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Looking for Tax Savings on Gifted Assets

Howard Hook, CFP®, CPA, quoted in The Star Ledger's business/finance column, "Biz Brain" on February 20, 2013

Question:  Can I give stocks directly to my children from my required minimum distribution from my 401(k)? Basically, I would like to transfer up to $13,000 per child of stocks from that account so the transaction will not be taxable to me or my children. Up to now, I was taking out funds from my 401(k) and paying taxes as ordinary income. Second, can I give my U.S. Savings Bonds to my grandchildren for their education, placing them in a 529 plan, so that the interest on the bonds will not be taxed either to me or the grandkids? -- Grandpa WB

Answer:  You don't really have tax-free options for your 401(k) plan. A distribution is a distribution. You added money to your 401(k) plan over years pre-tax, so when you take the money out, the tax man wants his piece.

“The only way to transfer assets from a 401(k) or any qualified retirement plan without paying taxes is by doing a rollover to another qualified plan or IRA,” said Douglas Duerr, a certified financial planner and certified public accountant with U.S. Wealth Management in Montville. “You cannot outright gift assets from within a 401(k) to any other individual. You would need to take a distribution out of the plan personally, then transfer the assets to that person. This is a taxable event and you would also have to liquidate that position to do this,” he said.

If you have a Roth IRA, you could partially accomplish what you want to do, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

“Assuming you met the age and holding period for a Roth IRA, you could distribute stocks out of your Roth IRA and then gift them to your children and no income tax would be paid,” he said. “However, remember with a Roth IRA you have paid tax on some portion of the account already so the only portion that would really be going to the children tax free are the earnings in the account.”

As for gifting your bonds, it's possible, but you'd need to pass a few tests to make sure the transaction is allowed. Duerr said there are also income caps that could limit or make this unavailable to you, he said.

Hook said IRC Code section 454(a) requires a taxpayer who is deferring the taxation of interest on Series EE Savings bonds to include the accrued interest in taxable income if the bond is transferred, sold or gifted to someone else.

Therefore, gifting the bonds to your grandchildren would trigger taxation, he said.