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What’s the Tax Liability for Heirs Who Inherit Retirement Accounts?

MP900404926Retirement accounts are part of your taxable estate. However, if your assets are below the federal exemption levels, your heirs won’t have to pay an estate tax. However, they will have to pay taxes on their withdrawals.

A person who is updating their estate plan is wondering what will happen when his robust retirement accounts pass to his children. Retirement accounts like 401(k)s, 403(b)s, traditional and Roth IRAs and others are considered part of a taxable estate, Motley Fool’s recent article, which asks “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?”

For 2019, this is $11,400,000, and in 2020, the exclusion will be raised to $11,580,000. If you total all of your assets’ value, only the amount in excess of the exclusion will be taxable. Therefore, if you have a $12 million estate and die in 2020, only $420,000 of your assets would be subject to estate taxes.

Let’s look at another example: if your assets, including your retirement savings, total up to $5 million, your heirs won't be required to pay any estate tax whatsoever.

However, while they may not have to pay estate taxes, remember that withdrawals from most retirement accounts (except Roth IRA accounts) will be deemed to be taxable income. Thus, estate tax or no estate tax, if your heirs are in a pretty high tax bracket, inheriting your retirement savings may increase their tax liability.

Don’t neglect to check with an estate planning attorney about your state’s estate and inheritance taxes. There are a handful of states that have their own estate taxes, and their thresholds may be lower than the IRS’s.

There are now six states with an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

Another reason to update your estate plan is that each state has its own laws about inheritance taxes exemption and rates. If those laws change, your estate plan needs to change with them. Good tax planning is part of a complete estate plan, and your estate planning attorney will have some good ideas for you to protect your heirs.

Reference: Motley Fool (November 8, 2019) “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?”