One of the most important reasons we work to grow our wealth is to leave something behind for our loved ones. For my parents, this was not an option. They were entrepreneurs and immigrants who were not aware of all their savings and retirement options. Thankfully, I have been fortunate enough to be able to build a life on their shoulders—and that includes building a diversified retirement portfolio that allows me to leave something behind for my loved ones.
While an individual retirement account (IRA) cannot be gifted directly to another person, an IRA can work as a vehicle for building generational wealth—with the right amount of research and planning.
An IRA Cannot Be Given to Another Person.
The IRS explains that an IRA is “for the exclusive benefit of you and your beneficiaries.” While an IRA account itself cannot be gifted, you can remove the assets from your IRAs and then pass those assets on to other people as a gift. Here are three different options for accomplishing that.
1. Withdraw Money from an IRA.
Say you would like to give some of your IRA funds as a gift during your lifetime. One way to potentially accomplish this would be to make a withdrawal and then pass the proceeds on to loved ones, like children or grandchildren.
However, it is important to note that such a gift is not tax-free. If money is being withdrawn from a traditional IRA, income tax will need to be paid on the amount withdrawn, and if you as the IRA account holder have not reached the age of 59½ years old, you will likely need to pay a 10% early withdrawal penalty on top of the income taxes.
Once taxes and penalties are paid, however, that money is yours to use or gift as you see fit. There are no constraints on use of the money. It can be given to a family member, donated to a charity, or used to purchase other assets.
But if you're gifting money from an IRA and it surpasses a certain amount, you may be required to file a gift tax return. For 2022, the tax-free limit for a gift is $16,000 per recipient.
Consult with your financial institution or tax advisor before making any IRA withdrawals. Everyone’s situation is different, and there are some exceptions to the taxes on IRAs.
2. Pass Along an IRA Inheritance.
Naming a beneficiary (or beneficiaries) is part of setting up your IRA. Once you pass away, whoever you have established as your beneficiary inherits the IRA and all its contents. There is a tax benefit here as well because an IRA in the name of a deceased person is not taxed when it’s inherited by that beneficiary. Once they inherit the IRA, the beneficiary must then completely cash out the entire IRA or transfer the funds to an annuity account.
This process is different for a spouse who’s designated as a beneficiary of an IRA. If you have your spouse listed as a beneficiary, they may treat the IRA account as though it had been theirs all along—they can withdraw money from the IRA account or leave the account untouched.
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3. Make IRA Contributions for a Child or Grandchild.
Another way to build generational wealth through an IRA is to contribute to an account in the name of a child or grandchild. This can be a great way to involve family members in your financial plans while having conversations that help introduce them to the importance of financial planning and financial literacy.
For 2022, the annual IRA contribution limit is $6,000 or the child’s earned income, whichever is lower. Contributions beyond that limit are taxed.
A child’s earned income could come from traditional work, such as walking dogs, babysitting, delivering papers, serving as a lifeguard, or working at a local fast-food restaurant. Money from an allowance or cash gifts does not count as income, explains Farm Bureau Financial Services.
If the child or grandchild is a minor, it’s recommended that the IRA be a custodial account overseen by a guardian (typically a parent or grandparent).
Contributions to a child’s or grandchild’s IRA count toward the annual limit for tax-free gifts ($16,000 per recipient in 2022).
As you can see, you have several options for passing on the contents of your IRA or otherwise using an IRA as a form of building generational wealth. With some research and planning, you may be able to make both your own future and the future of your loved ones more comfortable.
Generational wealth is a gift that leaves a legacy. Consider revisiting your IRA’s diversification and whether it may benefit from non-paper-based assets like physical gold and silver. Call U.S. Money Reserve to learn about diversifying your asset mix.
