530(A) Account to Roth Conversion: Minimizing Kiddie Tax with Early Retirement or Gap Year?
I love the ability to convert the 530(A) account to a Roth IRA, but I’ve read about the kiddie tax, and the benefit of waiting until the child turns 24 if they are in college, etc.
I’m wondering if I’ve done the math/reasoning correctly in the scenarios below, to minimize taxes on conversion?
Assumptions:
- Total Contributions (Basis): $50,000 (Tax-free)
- Projected Investment Growth: $25,000 (Taxable upon conversion)
- Total Account Value at Age 18: $75,000
Scenario 1: Early Retirement, No Earned Income
The year my child starts college (Sept 2036), I will (hopefully) also retire from my current job, and my plan is to live solely off of my savings coming from an HYSA or Roth contributions for the first 2 years. This would effectively give me $0 earned income in tax year 2037, and being divorced and the custodial parent, my child's unearned income (the $25k of projected investment growth), would be taxed at my marginal rate as follows:
Child Cap: My child would be permitted to use a maximum of $2,700 of their own brackets for unearned income. The first half is tax-free ($1,350), and the second half is locked at 10% ($135 tax).
Because I have $0 of income, the IRS would fill up my unused 10% bracket and 12% bracket with the remainder of the $25k of growth.
First $1,350: Tax-free (first half of child cap). $0 tax.
Next $1,350: Taxed at 10% (second half of child cap). $135 tax.
Next $12,400: Shifted, taxed using my unused parental brackets. Taxed at 10%. $1,240 tax.
Remaining $9,900: Taxed at 12% using my parental bracket. $1,188 tax.
$2,563 Total Federal Tax Bill.
Scenario 2: Child Takes a Gap Year
As far as I understand the Kiddie Tax: The IRS applies the Kiddie Tax to all 18-year-olds unless they provide more than half of their own financial support using their own earned income (wages from a job).
For young adults aged 19 to 23, the Kiddie Tax only applies if they are full-time students.
The IRS defines a full-time student as anyone enrolled in school full-time during any part of 5 calendar months out of the year
My child is a late school birthday, born in October. They turn 18 in October of 2035, graduate high school in May of 2036, and would typically start college in September of 2036. If they defer for a year, this means they turn 19 in October of 2036, and would not start college until September of 2037.
Therefore, in the tax year of 2037, at ages 19 to 20, they will only have attended school full-time for four months of the year (Sep, Oct, Nov, Dec), giving them non-student status, meaning the Kiddie Tax would not apply.
If I convert the full 530(A) account amount to a Roth IRA during 2037 in this scenario, the entire conversion would be taxed strictly using my child’s own independent tax brackets. If they do not work and have $0 in earned income (let’s say they take the year to travel, funded by me, all falling within the lifetime gift tax exemption), then the following is true:
Assuming the 2026/2027 standard deduction of $16,100, the $25,000 of 530(A) Account growth would be taxed like this:
Tax-Free Layer ($16,100): Covered entirely by the Single Standard Deduction. $0 tax.
10% Bracket Layer ($8,900): The remaining growth taxed at the lowest bracket. $890 tax.
$890 Total Federal Tax Bill.
If the above scenarios are accurate, then I see a huge benefit to doing a lump-sum conversion to a Roth IRA in 2037 in either case, rather than waiting until age 24/25 when my child's earned income from their first job would also impact the conversion tax rates, but am I missing anything?