Inherited Retirement Plans..the Hidden "Estate" Tax

Over the past few decades, as employers have moved away from pensions, and the concern about the funding of Social Security has increased, employees have been advised to put money away into their 401K, 403B, IRA etc. during their working years to save for retirement.  Many have heeded the advice and over the years have grown a nice nest egg for retirement.  

What many of these individuals are unaware of is that many types of retirement accounts are taxed when they are withdrawn.  Not only are the distributions from these plans taxable during life, but the beneficiaries who may receive a retirement plan as part of their inheritance will be taxed on future distributions. 

As the federal estate tax exclusion has increased over the past decade from $1 million to now $11.18 million before an estate is subject to estate tax, the majority of our clients are no longer concerned about estate tax consequences but rather the income tax impact on their tax-deferred plans.  Thankfully there are a few options to reduce the taxable effect on these distributions. 

1. During life, if the taxpayer has reached the age of 70 1/2, (s)he must begin taking Required Minimum Distributions ("RMDs").  This requires the taxpayer to withdraw a percentage of their total tax-deferred assets each year based upon his/her life expectancy.  One way to reduce the tax on these distributions is to make charitable contributions directly from an IRA to the charity by way of a Qualified Charitable Distribution ("QCD") (see blog post on June 27, 2017) on these distributions.  

2.  Inherited IRAs. Upon death, a retirement plan can be distributed in a number of ways.  Your plan may designate a beneficiary spouse, child, another person, charity, or trust.  How the plan will pay out to your beneficiary may also depend on whether you began taking RMDs during your lifetime. 

3. Charitable Bequests.  If your estate plan includes specific bequests to charities or other 501(c)(3) organizations, it is best to have the tax-deferred funds distributed to the charities so they can receive the assets that would otherwise be subject to tax.  The remaining non-retirement assets can then pass to other beneficiaries tax-free since most other assets would receive a step-up basis upon your passing and would result in little if any tax upon the sale.

It is important to review and update your estate planning documents. If you would like to have one of our attorneys review your current estate plan or if you have any questions, please feel free to contact Glick and Trostin, LLC at 312-346-8258.

Disclaimer: The materials on this website are provided for informational purposes only and do not constitute legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between any attorney and any other person, group or entity. No representations or warranties whatsoever, express or implied are given as to the accuracy or applicability of the information contained herein. No one should rely upon the information contained herein as constituting legal advice. The information may be modified or rendered incorrect by future legislative or judicial developments and may not be applicable to any individual reader's facts and circumstances.