Withdrawal from Keogh a mistake

Moneyline

Dollars & Sense

December 26, 1999|By Liz Pulliam | Liz Pulliam,LOS ANGELES TIMES

We gave our granddaughter $10,000 from my wife's Keogh this year. We had started taking annual distributions from the account, although for a smaller amount. Our income tax preparer said the gift is not deductible. Our son, who is very knowledgeable about income taxes, says this is a one-time gift to a relative and is deductible. Who is right?

Not your son, that's for sure. Gifts to individuals are never tax-deductible, one time or any time. This makes me wonder what other advice he's given that could be injurious to your financial health.

He should have warned you not to take the money from the Keogh. Keoghs are tax-deferred retirement savings accounts for the self-employed. That means you have to pay taxes, at your regular income tax rate, on every dollar you withdraw. Any withdrawn dollars are thus no longer earning tax-deferred returns. So in one fell swoop you've added hundreds of dollars to your tax bill while giving up hundreds or even thousands of dollars in tax-deferred future earnings.

Generally speaking, you should delay tapping your retirement funds for as long as possible to prolong the time you have to earn tax-deferred returns. Any gifts should be made from money that has been taxed already.

I'm guessing your son confused the gift-tax rules with rules about deductibility. Gifts of $10,000 or less aren't subject to gift-tax reporting rules, and financial planners often recommend such gifts as a way of reducing the size of your estate and thus any future estate taxes. This only becomes an issue when your estate is worth more than the exemption amount, which is currently $650,000. (And it might not be an issue at all if you don't care how big a bite Uncle Sam gets after you're gone.)

Next time, consult your tax adviser before you make a gift or take any other action involving a retirement fund. You'll save yourself some grief at tax time.

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