Can You Gift an IRA to a Family Member?

Individual Retirement Accounts (IRAs) are a popular tool for retirement savings, offering significant tax advantages. However, sharing the benefits of an IRA with family members can be complex. Understanding the rules and implications of gifting an IRA is essential for anyone considering this option.

Rules for Transferring Ownership

Transferring ownership of an IRA is not as simple as transferring other assets. The IRS enforces strict regulations to preserve the tax-advantaged status of these accounts. IRAs cannot be directly gifted to another individual during the account holder’s lifetime. This restriction reflects the intent of IRAs to provide retirement income specifically for the account holder.

The only exception for transferring an IRA during the account holder’s lifetime is a “trustee-to-trustee transfer” in divorce cases. This type of transfer, permitted under a divorce decree or separation agreement, avoids tax penalties and ensures the account retains its tax-advantaged status.

After the account holder’s death, IRAs can be passed to beneficiaries designated on the beneficiary form, which overrides instructions in a will. Beneficiaries can choose a lump sum distribution or transfer the funds into an inherited IRA. The latter option allows continued tax-deferred growth but requires adherence to required minimum distribution (RMD) rules, which differ from those for the original account holder.

Tax Implications for Donor

Donors must carefully consider the tax consequences of gifting IRA funds. Any distribution taken from an IRA for gifting purposes is treated as ordinary income and taxed at the donor’s current income tax rate. For instance, a donor in the 24% tax bracket would owe taxes on the entire distribution amount at that rate, potentially increasing their tax liability for the year.

Withdrawals from a traditional IRA before age 59½ generally incur a 10% early withdrawal penalty unless specific exceptions apply. This penalty, combined with the tax liability, can make early gifting costly. Additionally, withdrawing funds for gifting may reduce the donor’s resources for retirement.

IRA distributions used for gifting may also affect estate planning. While IRAs cannot be directly transferred during the account holder’s lifetime, any distributions could contribute to the donor’s taxable estate. If the donor’s estate exceeds the federal estate tax exemption threshold—$13.2 million for 2024—this could result in additional estate taxes.

Tax Implications for Recipient

Recipients of IRA funds, whether through inheritance or gifting, face specific tax considerations. Inherited IRA distributions are recognized as taxable income in the year received, affecting the recipient’s tax return. For example, a recipient in the 22% tax bracket receiving a $50,000 distribution would owe $11,000 in federal taxes, excluding potential state taxes.

Recipients can opt for a lump sum distribution or spread withdrawals over several years through an inherited IRA. Spreading withdrawals allows income to be recognized incrementally, potentially keeping the recipient in a lower tax bracket and enabling continued tax-deferred growth. However, under the SECURE Act, inherited IRA funds must be fully withdrawn within 10 years of the original owner’s death unless the recipient qualifies for exceptions, such as being a minor child or surviving spouse.

Alternatives to Direct Transfer

Those seeking to share the benefits of an IRA without direct transfer can consider other strategies. One approach is naming a trust as the IRA’s designated beneficiary. This allows the account holder to control how assets are distributed after their passing, which can be useful if beneficiaries lack financial expertise or responsibility.

Another option is using the IRA for a Qualified Charitable Distribution (QCD). Individuals aged 70½ or older can transfer up to $100,000 annually from their IRA directly to a qualified charity. This strategy satisfies required minimum distribution (RMD) obligations while reducing taxable income, benefiting both the donor and the charitable cause.

Reporting Requirements

Properly documenting IRA-related transactions is essential for compliance with IRS regulations. Donors must report distributions on IRS Form 1099-R, provided by the IRA custodian. This form details the distribution amount and its taxability. Donors must include this information on their tax return, typically on Form 1040, and report early withdrawal penalties, if applicable, on Form 5329.

Recipients must also accurately report inherited IRA income. They will receive their own Form 1099-R reflecting the distributed amount, which must be included on their tax return. Recipients of inherited IRAs subject to required minimum distributions (RMDs) must calculate and withdraw the appropriate amount annually. Failing to meet RMD requirements can result in a 25% excise tax on the shortfall, as outlined in IRC Section 4974. For those spreading distributions over the SECURE Act’s 10-year period, careful tracking and annual reporting are crucial to avoid penalties.