Even if you think you’ve covered all the bases when it comes to your estate planning, if you haven’t prepared your children for the inheritance they will receive one day, you still have work to do.
Parents can find many reasons for putting off this discussion because it can be uncomfortable. You don’t want to upset yourself and your children by discussing your own mortality and you may not be comfortable talking about money. But if you have already made the effort to create an estate plan, you should be sharing it with your heirs so they can prepare themselves for what’s ahead and plan accordingly. Here are five things they should know about their inheritance:
1. Tax consequences of inherited IRAs.
Your children will pay tax on an inherited IRA just as you would. However, they can choose the “stretch” IRA option that leaves funds in the IRA for as long as possible while they take required minimum distributions based on their own life expectancy. Those RMDs begin the year following the death of the original IRA owner. If they don’t use this option, they have to liquidate the account within five years. And taking a lump sum will cost them — 40% or more of the assets in the account.
2. No rollover, no do-over.
Only spouses can roll over inherited IRAs into their own IRA or 401(k). If your children try to do this, they can expect a big tax bill since the entire amount becomes taxable income. And once they do it, there is no do-over to undo it. To make sure this doesn’t happen, be sure the custodian of your IRA administers the inherited IRA for your children and ensures the required minimum distributions are made so they don’t incur a tax penalty of 50% on any RMD not taken in addition to income tax on the full RMD amount.
3. Taxes on annuities.
Inherited annuities and other non-retirement tax-deferred assets come with a ticking tax bomb. Your child will receive a 1099 from the insurance company and the full amount must be counted as gross income on their federal income taxes. Be sure they know about this if these types of assets are part of their inheritance.
4. Understanding cost basis.
If you are leaving your children any real estate, stocks, bonds or other non-retirement account appreciated assets, they need to understand the term, “step-up in basis.” The value of any of these types of assets is based on what the asset was worth on the day you died, not on what you paid for it. For example, if you bought a piece of real estate for $200,000 and it is worth $400,000 on the day you die, the cost basis for your heirs is $400,000. If they sell the property for more than $400,000 at any time in the future, any capital gains tax would be calculated on the “stepped-up basis” of $400,000.
5. Who can help.
Consider setting up an appointment with your estate planning attorney and/or financial adviser for you and your children. If you all live far away from each other, this can be done via phone or video conference. Be sure your children have the contact information for your attorney and adviser so they can reach out for the advice they will surely need after you’re gone.
Your legal team at Koenig|Dunne is here to provide you with guidance and advice regarding all of the issues that you will face throughout the estate planning process.