Taking advantage of a terminal illness

[Mr Fixit]

My father-in-law was diagnosed with stage 4 cancer last year.  We don't know how long he has left, but the 1 year survival rate is 40% and the 5 year rate is in the single digits so in the grand scheme of things he won't be around all that long. 

I've been going over a bunch of financial stuff with him to make sure all his stuff is in order for when the inevitable comes.  When I noticed he didn't have a Roth IRA I had an idea.  If we fully funded the IRA for 2014, and 2015, and put my 7 year old daughter as the beneficiary, she would inherit a Roth that could potentially grow forever.  I ran some quick calculations and at a 6% return for between now and when she was 60.  She would have to take out about $63000 in required distributions and would have a balance of over $90000 at that point.  At 8% return those numbers are roughly doubled.  If he makes it until next year, we could add another $6500 to the account, making it even better.

I am aware of the downsides that my daughter would have full control of the account when she is 18, and the fact that my FIL could change the beneficiary without me knowing about it.  My FIL gets all his medical care from the VA, so there is little risk of medical expenses sucking up the account.  Congress could change the rules on Roths as well.  Is there anything else I am missing?

Assuming we move ahead with this, what would be the best investment options?  I would probably want something that threw off some dividends to cover the RMDs each year.  Vanguard Total Stock Market Index is always popular, but something like VIG or SDY might be appropriate as well.  Any recommendations?

[Gone Fishing]

Sorry to hear about your FIL.  Is he still (or your MIL) working? I ask because he needs earned income to fund the ROTH. 

[Mr Fixit]

His wife is still working, so there is no problem with the contributions.

[Heckler]

What about inheritance tax implications, which I know nothing about?

[minority_finance_mo]

I have nothing to add here except that you could have worded both the title and your OP more tastefully with respect your FIL's condition.

[merula]

What about inheritance tax implications, which I know nothing about?

An estate tax filing is only required for estates with combined gross assets and prior taxable gifts exceeding $5,430,000 for decedents dying in 2015. If that's your FIL's situation, he probably has a tax attorney who can help out.

[Bracken_Joy]

I have nothing to add here except that you could have worded both the title and your OP more tastefully with respect your FIL's condition.

I'm just really hoping the wife isn't on this forum....

[secondcor521]

Setting aside the tackiness...

As long as your MIL and FIL are married and she makes at least $6500, then yes, he would be eligible to contribute.

If he names her directly on the Roth IRA as his beneficiary and it passes outside of probate, then she should be able to treat it as a stretch IRA.  Under that scenario, she would be subject to annual RMD withdrawals based on her life expectancy.  A Putnam investment site claims the RMDs would not be taxable income to your daughter (https://www.putnam.com/literature/pdf/IR705.pdf) which I didn't know.

Some states (like mine) use 21 as the age of majority; check your state's laws.

Whether you use dividends from the IRA to pay the RMDs or whether you sell shares is irrelevant from a taxation point of view.

Personally I like VTSAX, but whatever floats your boat investment-wise is what you should do.

Consult your own tax and investment advisors, blah blah blah....

[Ohio Teacher]

I have nothing to add here except that you could have worded both the title and your OP more tastefully with respect your FIL's condition.

+1.  "If he makes it until next year, we could add another $6500 to the account, making it even better."  This is where I cringed the most.   This whole situation feels wrong.  Are your wife, MIL, and FIL on board?  I can think of dozens of things that would go through my mind if my FIL was dying, and none of them entail getting involved with his finances.  I really think you're going to regret some part of this.

[shadowmoss]

Some families are comfortable being matter-of-fact about death and financial issues and others aren't.  My family is pretty matter-of-fact, and I didn't see anything wrong with the OP's post.  I am assuming that the FIL fully aware is in full support of all this.  Again, assuming a positive relationship, he might be grateful to be able to leave something to his grandchild that will benefit her long after he is gone.

[Mr Fixit]

Wow.  I didn't expect the negative response I got from this.  I guess people just think very differently than I do. 

My family is very pragmatic.  It isn't like we can do much about his illness except to wait for the inevitable to happen. We are of course taking advantage of the time we have left with him by spending time with him, etc. 

As far as being involved with his finances go, prior to the diagnosis, he asked me finance related questions and advice on a (semi)regular basis.  He is VERY worried about getting all of his concerns in order and has specifically asked for my help both in financial as well as other matters.  He expressed an interest in doing something more for his granddaughter.  To leave a legacy.  This was one thing he could do.  The entire family is on board with this idea.

He asked me:  "You mean this would screw the government out of the taxes on the growth for as long as she lives?"  He smiled for 10 minutes when I told him that was essentially the case.  I don't see many smiles from him these days.  He couldn't have been more pleased with himself.

[mxt0133]

When individuals inherit and IRA (or Roth IRA) the RMDs will be based on the life expectancy of the individual.  So your daughter will have to take out distributions based on a factor that is set on her age after you FIL passes away every year.   Not as good as tax deferred growth until she is 60 but good enough.  It will then go to a UGMA or UTMA custodial account and any earning from those investment are tax free up to about $2100 a year and anything above that will be taxed at the parents highest marginal rate.

[Argyle]

Yes, I have an inherited IRA, and I can vouch for the fact that you have to start taking the required distributions (calculated over the lifetime of the inheritor) the year you inherit.  It does eat away at the amount.  Only a small percentage of it will be left when she's 60.  Let's say her estimated life expectancy is 70 more years; she'll be required to take 1/70 of it per year, and smaller and smaller amounts will be earning more of itself.  Maybe better than nothing but not a total bonanza.

[TheOldestYoungMan]

Yea in my family figuring out ways to avoid taxes is. the. whole. point of managing your money properly.  It's the true American Past-time.

Does the RMD change every year, because 1/70 seems to be below the SWR.  What's the monte-carlo show on 12k over 70 years with that?  I'd imagine it grows.

I think an IRA and a Roth IRA can be rolled over into an existing equivalent account owned by the surviving spouse, and you can avoid the RMD for a little while that way.  I don't know the age of the daughter you want to get it or what you want her to use it for, but getting a larger account in her 30's when grandma bites it might be better.

From the internet:

"The model agreement from the IRS provides for an automatic spousal rollover if the spouse is the sole beneficiary of the IRA. That means the surviving spouse automatically would become the new owner of the Roth IRA upon the death of the original owner. Note: The surviving spouse would need to name their beneficiary as soon as possible after the death of the original owner in order for the rollover to be beneficial. If a Roth IRA Agreement does not provide for a spousal rollover, a surviving spouse would still have the option to elect to rollover the Roth IRA to become the new owner. Why would you want to accomplish a spousal rollover after the death of the original owner? If the surviving spouse becomes the new owner, there will no requirement for distributions to be made during the life of the surviving spouse! That will result in additional tax-free growth of the account during the surviving spouse's lifetime. A surviving spouse could take distributions as a beneficiary, but there would rarely be any benefit to doing so."

I remember digging into this years ago and thinking that a Roth IRA is a super awesome thing to leave behind, because the money they get from it won't hose their current tax plan.  It's just neat how it exists outside the tax-continuum.

I'm not sure it's really going to matter either way, IRA or Roth.  The time horizon here is just not that long.  The instant tax savings on the IRA may make more of a difference than any savings on capital appreciation from the Roth.

Also, Grandma might find a new man.  Something crazy like 70% of new STD's are acquired by people over 65.  Old people are sluts yo.

My condolences.

[Ohio Teacher]

He is VERY worried about getting all of his concerns in order and has specifically asked for my help both in financial as well as other matters.  He expressed an interest in doing something more for his granddaughter.  To leave a legacy.  This was one thing he could do.  The entire family is on board with this idea.

He asked me:  "You mean this would screw the government out of the taxes on the growth for as long as she lives?"  He smiled for 10 minutes when I told him that was essentially the case.  I don't see many smiles from him these days.  He couldn't have been more pleased with himself.

If you would have included this part of the story in the OP, I would not have commented the way I did.  Sorry for misunderstanding the situation.  Good luck.  VTSAX, all the way.

[seattlecyclone]

Something to consider instead of (or in addition to) the Roth IRA is a 529 plan for your daughter. She'll have about ten years to let that money grow tax-free with no RMDs, at which point it would pay for a pretty sizable portion of her college education.