It’s great that you have met with an estate planning attorney and coordinated your estate plan, working with your CPA and financial advisor in a team effort to bring about the best possible situation from a tax planning and investment perspective. However, if you’ve forgotten to speak with your children about the estate plan, you’ve still got a gaping hole in your estate plan.
Kiplinger’s recent article, “5 Things Your Kids Should Know Before They Inherit Your Money” explains that for many, this happens because it’s too personal and too uncomfortable. Most people who sit down with an estate planning attorney want to pass it on in the most efficient manner possible and lessen any tax burden, if they can.
You should, at the very least, have a general conversation about where your money is, how to get to it, and how to minimize the taxes on various types of investments when they’re inherited. Here are some things you and your heirs should know:
Tax ramifications of inherited IRAs. If your children inherit your IRA, they’ll be paying taxes on withdrawals, just like you were. Your beneficiaries can opt for a “stretch” IRA option, leaving the funds in the IRA for as long as possible while taking required minimum distributions (RMDs) based on their life expectancy (their RMDs would begin the year after your death, not by age 70½), or they must liquidate the account within five years. It is important to discuss the potentially drastic tax consequences of taking a lump sum, as beneficiaries could lose up to 40% or more of the account.
IRA rollovers. A non-spouse beneficiary can’t roll your IRA money directly into his or her own IRA or 401(k). If they do, it could trigger a major tax bill because the whole amount would become taxable income and there’s no do-over. Be sure that your IRA custodian will administer inherited IRAs for your children and will automatically take care of any required minimum distributions. If your loved ones don’t take the required amount, the tax penalty is 50% of whatever they were supposed to take, plus whatever their ordinary income tax rate would be on that amount.
Inherited annuities. Other non-retirement tax-deferred assets, such as annuities, also can come with a tax time bomb when they’re inherited. The insurance company will issue a Form 1099 for any untaxed growth to your child. That amount must be included as gross income, when they file their taxes.
Step-up in basis. This can impact some non-retirement account appreciated assets that are inherited, like stocks, bonds and real estate. The value of the asset on the day you die will be your heir’s cost basis, not what you paid for it. Therefore, if your child sells the asset for more than that at-death value, any capital gains tax will be calculated based on the stepped-up basis, not the original basis.
Who will help your kids? Have your beneficiaries meet with your estate planning attorney while you are alive. This gives the family a chance to ask questions, get comfortable with each other and understand what will happen when you pass.
The worst time for many families is after a loved one has died. It’s not the time to start learning about investments, taxes and property law. You can lighten that burden by discussing your estate plan with your family now.
Reference: Kiplinger (January 29, 2018) “5 Things Your Kids Should Know Before They Inherit Your Money”