Are You Leaving a Tax Bill for Your Beneficiaries?

If you’re like many retirees, a large portion of your assets may be held in qualified accounts like an IRA or a 401(k) plan. Qualified accounts make for effective retirement savings vehicles because of their unique tax treatment. Earnings and investment gains aren’t taxed as long as the funds stay in the account. That may allow your funds to compound at a faster rate.

The tax bill will be due eventually, though. If you take distributions from your qualified accounts, you will likely face income taxes on those withdrawals. Roth IRA accounts allow for tax-free withdrawals after age 59½, but most other qualified accounts have taxable distributions.

What happens, though, if you pass away and leave a sizable qualified account balance to your beneficiaries? They will likely face the same tax treatment on the death benefit that you would have faced on retirement distributions. In other words, the death benefit for a traditional IRA or 401(k) is usually taxed as income, just as distributions are taxed.

While you may want to pass your assets on to your loved ones, you may not want to leave them with a sizable tax bill. If the assets are substantial enough, the death benefit could even push your beneficiaries into a higher tax bracket.

Fortunately, there are steps you can take to minimize the tax obligation. Below are three steps to consider:


Take your required minimum distributions on time.

In most qualified accounts, you are required to take distributions starting at age 70½. The amount of these required minimum distributions, called RMDs, is based on the balance of your account and your life expectancy. They usually increase as you get older.

If you don’t take your RMDs, you’ll face up to a 50 percent excise tax on the distribution. If you don’t pay the excise tax, it’s usually tacked on to the taxable distribution after your death. So your beneficiaries will face not only income taxes on their benefits, but also any unpaid excise taxes for RMDs that you failed to take.

The easiest way to minimize this threat is to take your RMDs as scheduled. If you miss a distribution, it’s often wise to correct the mistake as soon as possible and pay the excise tax. A financial professional can help you manage your RMD obligations.


Consider a Roth conversion.

Are much of your assets in a traditional IRA? If so, you may want to consider a strategy known as a Roth conversion, which is the process of transitioning traditional IRA funds into a Roth IRA. You have to pay taxes on the converted amount. However, you’ll avoid taxes on future distributions, and your beneficiaries won’t face taxes on their death claim.

A Roth conversion isn’t for everyone, so review it carefully before moving forward. The strategy often works best when you can pay the conversion tax from non-IRA assets and when you can allow the new Roth funds to accumulate before starting distributions. If you need income now, a Roth conversion may not be the best strategy.


Talk with your loved ones.

Your beneficiaries will likely have a range of options for how they take their benefit after you pass away. While the distribution may be taxable, that doesn’t mean they have to pay the taxes all at once. They may have options to spread the income and taxes over several years or even over their lifetime.

Talk with your beneficiaries about your qualified accounts and their death benefit options. If they understand their options in advance, they can plan ahead and manage the tax obligation.

Ready to start the planning process? Let’s talk about it. Contact us at TB Financial. We welcome the chance to help you analyze your needs and develop a plan. Let’s connect today.


This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.

16357 – 2017/1/18

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