I will soon receive $285,000 in divorce settlement from my ex-spouse’s 401(k).
I would like to help one of my children with $7,000 in student loan debt and another with $18,000 in credit card debt.
Can I gift this money to them without being taxed to death?
tax planning parent
Dear parents,
After going through the ordeal of divorce, I received some good news. You can help the children, but you will have to pay taxes along the way.
In 2023, you can gift up to $17,000 per recipient before gift taxes apply. (The gift tax deduction is indexed to inflation, so the maximum deduction may increase each year. Keep an eye on the 2024 amount.)
But let’s assume you already have cash on hand.
You can cancel $7,000 in student loans for one child. You can also erase $17,000 of her $18,000 credit card bill. The remaining balance will be repaid the following year.
Another option, says Luis Rosa, founder of Build a Better Financial Future in Pasadena, Calif., is if the child with credit card debt is married, you could give the remainder to their spouse. Stated.
Relationship between children’s debt and retirement
The bigger question is whether you should use that money to pay off your children’s debts or focus on your own retirement.
“This is money that will go toward retirement,” said Rob Seltzer of Seltzer Business Management in Los Angeles, Calif., adding, “Kids are borrowing to buy a home or consolidating credit card debt. You can do that,” he said. You cannot borrow money for retirement. ”
Scott Bishop, partner and managing director at Presidio Wealth Partners in Houston, Texas, recommends considering a qualified domestic relations order.
a QDRO Directing a retirement plan to pay a spouse or ex-spouse to pay child support, alimony, or marital property rights, including cash, securities, bank and retirement accounts, and pensions earned during the marriage. Masu.
Withdrawal fine for those under 59 1/2 years old
If $285,000 worth of QDRO funds were transferred directly to your IRA, you would wouldn’t pay taxes I’ll do it now, Bishop said. Your money grows with deferred taxes.
Of course, if you withdraw from your IRA in retirement, tax consequences apply, but by then you may find yourself in a lower tax bracket.
But if you spend $25,000 to eliminate your children’s debt, that money is immediately subject to income taxes, Bishop said.
As a general rule, 401(k) distributions based on QDROs skip If you are under age 59 1/2, there is a 10% early withdrawal penalty. However, if you’re not that age, check with a professional to see if your 10% early withdrawal penalty applies to your $25,000.
Once the divorce settlement reaches the IRA, withdrawals before age 59 1/2 are subject to a 10% early withdrawal penalty, Rosa said.
long term retirement planning
But be careful about how you spend this 401(k) money.
“It’s not just the money that’s taxed, it’s the opportunity for that money to grow tax-free for years,” said Michael Statman, a husband-and-wife attorney and partner at Alter Wolfe Foley & Statman in New York. We will lose it.” Statman said money from your ex-husband’s 401(k) is a “last resort.”
Bishop agrees. If you want to do this, use money you have in your bank or brokerage account.
Bishop says we need to ask ourselves about the messages we’re sending to our children.
“You don’t want to set your child up to make bad decisions in the future by mitigating bad financial decisions in the past,” he says.
I can totally relate to your desire to help your children as a caring parent. We don’t know your family’s backstory or how much work your children have worked to get to where they are, but financial decisions can also teach useful life lessons.
Have tax questions? Email us: akeshner@marketwatch.com
thank you for reading. We want to help you think more broadly about issues that affect your taxes. I am not providing tax advice. However, I would like to consider how the swirling tax and economic situation may affect your wallet.
I’m here for readers who are facing their taxes with a resigned mindset. I know you’re not that interested in taxes. I was once such a man. Under the terminology, think of taxes as a maze. In the end, it comes down to money. Or traps that need to be avoided.
