For many investors, a large portion of their investments are held in 401(k)s, IRAs, or other tax-favored retirement vehicles. While these accounts can be ideal for sheltering retirement savings from taxes both preretirement and post-retirement, they can also be highly vulnerable to tax losses in an estate, if they are not bequeathed properly. For instance, a $1 million IRA inheritance could be whittled to almost nothing under worst-possible circumstances, such as a combination of estate taxes, top income tax brackets, and missed withdrawal deadlines. Avoiding these pitfalls means knowing the rules and planning in advance.

Here are some tips you may want to share with clients:

1. Select a beneficiary — If no one is named, the assets could end up in probate, and beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal, because they have several options that aren’t available to other beneficiaries, including the marital deduction for the federal estate tax and the ability to transfer plan assets — in most cases — into a rollover IRA.

2. Consider the options for multiple beneficiaries — If an individual wants to leave his or her retirement assets to several younger heirs (such as your children), the IRS has issued “private letter” rulings that suggest that the assets in a stretch IRA may be split into several accounts, each with its own beneficiary. This strategy, however, is not available if the IRA owner started taking RMDs before his or her death. That way, distributions will be based on each beneficiary’s age. In addition, these distribution rules provide added flexibility in that beneficiary designations need not be finalized until December 31 of the year following the year of the IRA owner’s death for the purposes of determining required distributions. Therefore, an older beneficiary (e.g., a son or daughter of the IRA owner) may be able to either cash out or “disclaim” his or her portion of the IRA proceeds, potentially leaving the remainder of the IRA proceeds to a younger beneficiary (e.g., a grandchild of the IRA owner). As long as this is done prior to December 31 of the year following the year of the IRA owner’s death, distributions will be calculated based on the younger beneficiary’s age.

3. Be generous — Plan assets given to charity are fully estate-tax deductible, and no income tax is due on this gift.

4. Consider an irrevocable trust The federal estate tax currently tops out at 40% of all assets in excess of a $5.43 million exclusion. While qualified plan assets do qualify for the unlimited marital deduction, such assets generally do not qualify for the use of the federal estate tax exclusion. Some estate planning experts have developed strategies using an irrevocable trust that can make qualified plan assets qualify for an individual’s federal estate tax exclusion. However, this type of planning is very complex and requires specialized expertise in estate planning.

Tips for Spouses

  • Consider a rollover IRA — Rollover IRAs permit some creative tax planning, such as setting up stretch IRAs for children or recalculating the distribution schedule for a spouse.
  • “Disclaim” IRA assets if a spouse doesn’t need them — If the spouse is the primary beneficiary of an IRA and a child is the contingent beneficiary, the spouse may be able to disclaim his or her right to the IRA proceeds. If done so by December 31 of the year following the year after the IRA owner’s death, future distributions may be based on the child’s age, effectively spreading those distributions out over a longer period of time.


RMD Rules Simplify Things

IRS rules for calculating the required minimum distribution (RMD) from IRAs and qualified retirement plans provide some longer-term planning advantages.

The premise behind retirement plan distributions is simple — the longer someone is expected to live, the less the IRS requires them to withdraw (and pay taxes on) each year. For specifics on the rules or how to calculate specific required minimums, go to the IRS website at

Keep in mind that if minimum amounts are not withdrawn when required, taxes can take half of what should have been withdrawn.

Tips for Nonspouse Beneficiaries

  • With stretch IRAs, don’t use the beneficiary’s name! — Under IRS rules, an inherited IRA becomes immediately taxable if the account is transferred into a non-spouse beneficiary’s name.
  • Watch the calendar — The account also becomes immediately taxable if the first required payout from an inherited IRA is not taken by December 31 of the year after the account owner’s death.


Points to Remember

  1. If retirement plan assets aren’t bequeathed properly, heirs could lose half of this inheritance to taxes.
  2. The longer one’s life expectancy is for distribution purposes, the smaller the annual tax bill will be.
  3. Some easy ways to make plan distributions more tax efficient for heirs include opening stretch IRAs, leaving a portion of retirement assets to charity, and potentially using an irrevocable trust.
  4. Plan heirs can reduce taxes on inherited plan assets by using rollover IRAs, observing minimum distribution deadlines, and taking special tax deductions, if eligible.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.

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