How to Pass on a Retirement Account

Estate planning is complicated: The fair decision may not actually be the most practical one. What does this mean? It means that even if you divide up your estate equally between your beneficiaries, they could get hit with unequal tax burdens. So, good estate planning requires more than just good intentions. If you plan on leaving a legacy, you should take each of your beneficiary’s finances into account when dividing up your assets.

Estate planning is so crucial because when a beneficiary inherits an investment account, they also inherit income tax liability. When someone inherits an IRA, they will owe federal and possibly also state taxes on the funds for as long as they make withdrawals. When someone inherits a taxable investment account, they pay taxes annually on interest and dividends in addition to capital gains. When it is passed on, unrealized gains are eliminated for the beneficiary, allowing the beneficiary to inherit the account with no income tax liability.

These facts matter even more if the beneficiaries are in different tax burdens. For example, if one beneficiary is in the 35% tax bracket, and another is in the 10% bracket, the first could end up with tens of thousands less than the second if they inherit equal amounts from an IRA because of their different tax burdens. To minimize taxes, the first beneficiary could inherit assets from taxable accounts, and the second could inherit IRA funds. On face value, these might be unequal amounts, but when each beneficiary’s tax burden is taken into account, the overall tax burden and the difference between what each end up with could be significantly reduced.

If you want to take on the tax burden instead of leaving it to your heirs, you can convert to a Roth IRA during your lifetime. Considering the relatively low tax rates and recent market volatility, you might be considering if now is the time to convert to a Roth IRA. That way, funds can continue to grow tax free in the account, even after it is passed onto a beneficiary.

Discussing significant estate planning steps can help avoid conflict between them if it appears that one is receiving more than the other. Explaining the complexities of tax burdens and taxable accounts versus tax advantaged accounts can be a good idea if you’re distributing your inheritance unequally.

Most importantly, be smart about your estate planning so that what you’ve earned gets passed on to the people who are important to you. The best plan isn’t always the simplest, so consult the professionals at ILG Financial. We can help you divide your retirement accounts and assets among your beneficiaries. Click here to schedule your no cost, no obligation financial review today.