Weekend Read: Tax Considerations on your Estate Planning
Hello everyone,
When people think about estate planning its often Wills, Trusts, and POAs that come to mind. While those are very important, the impact of estate planning on the accounts you leave to your heirs is often overlooked. Understanding how different types of accounts are passed on, can help you make more informed decisions and potentially save your heirs from unplanned tax burdens.
In the interest of keeping this post a reasonable length, lets stick to leaving assets to non-spouse heirs.
The Impact of Account Types on Your Heirs
Consider the difference in leaving $3 million in an IRA versus $1 million in taxable accounts, $1 million in a Roth IRA, and $1 million in a traditional IRA. Current tax law requires all IRAs to be distributed within 10 years of inheriting them. Many people inherit those IRAs during their working years and are able to leave them alone for a while, allowing them to grow. While that’s good, the complication is that at the end of the 10-year period, that account must be fully distributed which could lead to an enormous tax event.
Spreading the funds across different types of accounts offers a more tax-efficient inheritance. The taxable account benefits from a step-up in basis (all the gains from your lifetime are ignored and the account is treated like they bought everything on the day you passed), the Roth IRA provides tax-free distributions, and the traditional IRA, though still subject to the 10-year rule, would be a smaller portion of the overall inheritance123
Let’s take a moment and go deeper into each one of these.
Taxable Accounts: Stepping Up the Cost Basis
When it comes to taxable accounts, there’s a silver lining known as the "step-up in cost basis." This means that when your heirs inherit these accounts, the cost basis of the assets is adjusted to their value at the time of your death. For example, if you bought shares for $50,000 that are worth $100,000 at the time of your passing, your heirs would only be responsible for taxes on any gains above $100,000 if they sell the shares. This step-up can significantly reduce the capital gains tax they might owe2.
Traditional IRAs: The 10-Year Distribution Rule
Traditional IRAs, on the other hand, have a different set of rules. Prior to the SECURE Act of 2020, non-spouse beneficiaries were able to take a small distribution each year for life and really stretch out those taxes. Post 2020, most non-spouse beneficiaries must distribute the entire balance of the inherited IRA within 10 years. This can lead to a hefty tax bill, especially if the distributions push your heirs into a higher tax bracket. It’s important to plan for this and consider strategies that could minimize the tax impact, such as looking at income and distributing assets in lower income years or spreading distributions out over a number of years1.
Roth IRAs: A Tax-Free Inheritance
Roth IRAs offer a distinct advantage when it comes to inheritance. Since the contributions were made with after-tax dollars, distributions are tax-free for your heirs. While they still have to follow the 10-year distribution rule, they won’t owe any income taxes on the withdrawals. This makes Roth IRAs a powerful tool for tax-efficient estate planning3.
Planning Ahead
Effective estate planning requires a thorough understanding of these nuances to optimize the legacy you leave behind. Proper planning can help mitigate taxes and maximize the value of your estate for future generations.
As always, if you have any questions or need personalized advice, feel free to reach out. I’m here to help.
Enjoy your weekend!
Jeremy Raffer, MBA
Director & Wealth Manager
Author “Financial Planning for Widows”
m. 201-747-2705
e. jeremy.raffer@stewardpartners.com
Steward Partners
115 W. Century Rd, Suite 145
Paramus, NJ 07652
Steward Partners Investment Solutions, LLC (“Steward Partners”), its affiliates and Steward Partners Wealth Managers do not provide tax or legal advice. You should consult with your tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters.
Individuals are encouraged to consult their tax and legal advisors (a) before establishing a Retirement Account, and (b) regarding any potential tax, ERISA and related consequences of any investments or other transactions made with respect to a Retirement Account.
The case study presented is provided for illustrative purposes only. Past performance is no guarantee of future results. The information has been obtained from sources we believe to be reliable, but we cannot guarantee its accuracy or completeness. These strategies do not guarantee a profit or protect against loss and may not be suitable for all investors. Each customer’s specific situation, goals, and results, may differ. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security
1https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
2 https://taxfoundation.org/taxedu/glossary/step-up-in-basis/
3 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
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