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Bill
Bill, Enrolled Agent
Category: Tax
Satisfied Customers: 3151
Experience:  EA, CEBS - 35 years experience providing financial advice
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83 yo mother in good health has $5000/month pension with $2000

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83 yo mother in good health has $5000/month pension with $2000 month expenses. $300,000 in non-retirement accounts; $50,000 in traditional IRA. Two children will split assets. Both children in 35% tax bracket and not in need of money. What is the best way to get maximal amount of money to children-- gifting, Roth conversion, or other options?

Bill :

The mother is currently in at least the 25% marginal tax bracket based on her annual $60,000 pension income plus the required minimum distributions from her IRA. If she is also receiving social security benefits and taxable income from the $300,000 in non-retirement accounts then she may be just barely in the 28% bracket. If she converts the IRA to a Roth IRA, then she will pay federal income tax on the conversion amount at approximately a 28% rate. However, she will no longer have to take required minimum distributions and her children will inherit the Roth IRA income tax-free. If she doesn't convert then the children will inherit the traditional IRA and be forced to pay income taxes on withdrawals at their tax rates of 35% or higher (depending on tax rates in future years). If her gross estate is about $400,000, then federal estate and CO (if she is a resident there) estate taxes will not be an incurred so gifting is not a consideration for purposes of avoiding estate taxes. If the non-retirement assets consist of financial assets (such as stocks, bonds, mutual funds, etc) then any gifts of those assets will transfer the mother's cost basis on those assets to the children thereby losing the benefit of stepped-up date of death cost basis that would be available to heirs if instead they inherited those assets. However, one advantage of making gifts now would be that if the mother enters a nursing home more than 5 years after the date of the gifts (the look-back period) then those assets would be exempt from being considered resources in an application for medicaid eligibility.

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Stepped-up cost basis means that heirs assume the date of death fair market value of certain assets as their cost basis for purposes of determining the amount of gain or loss when those assets are eventually sold. For example, if the decedent owned common stock that he/she purchased for $10,000 and held until the date of death when the stock was valued for $100,000, then the heirs assume the $100,000 as their cost basis. If the heirs sell the stock for $110,000 then they only pay tax on a $10,000 gain ($110,000 - $100,000) because the cost basis is stepped-up from $10,000 to $100,000 (the fair market value on the date of death).