Legacy, Not a Tax Bill

Say you want to leave $1 million to your children. The first question is how much you're leaving. The next question is what kind of account that $1 million is sitting in.

A $1 million Traditional IRA, a $1 million Roth IRA and a $1 million brokerage account may all show the same number on a statement. They can look very different to the person who inherits them.

That's why legacy planning isn't only about how much is left. It's also about what your family actually receives and what they have to deal with after you're gone.

01The account matters

Money doesn't all pass to the next generation the same way.

A child who inherits a Traditional IRA or 401(k) will generally owe ordinary income tax as money comes out of the account. Under current rules, many non-spouse beneficiaries also have to fully distribute an inherited retirement account within 10 years, although the timing of distributions during that period can depend on the situation.

An inherited Roth IRA is generally much more favorable from an income-tax standpoint when the applicable requirements are met, although many non-spouse beneficiaries still face the 10-year distribution rule.

Taxable investments are different again. In many cases, inherited assets receive a new tax basis based on their value at death, which can reduce the capital gain built up during the original owner's lifetime.

	Traditional IRA or 401(k)	Roth IRA	Taxable investments
On the statement	$1 million	$1 million	$1 million
Income tax for the child	Ordinary income tax as money comes out of the account	Generally much more favorable, when the applicable requirements are met	Generally none on the inheritance itself
The 10-year rule	Many non-spouse beneficiaries must fully distribute the account within 10 years	Many non-spouse beneficiaries still face the 10-year rule	Does not apply
Built-up gains			In many cases a new tax basis at death, which can reduce the capital gain built up during the original owner's lifetime

Under current rules, as described in the text. The timing of distributions during the 10 years can depend on the situation.

Same family. Same amount of wealth. Very different tax treatment.

02Think about when your children may inherit it

The timing matters too.

If your children inherit from you when they're in their 40s, 50s or 60s, they may already be in some of their higher-earning years. Add taxable inherited IRA withdrawals on top of their salary, business income or other earnings, and the tax cost can be very different than it would have been for you during a lower-income year in retirement.

The tax bill doesn't disappear when you die. In many cases, it becomes part of your children's tax situation instead.

That doesn't mean a Traditional IRA is a bad asset or that you should spend it down simply to avoid leaving it behind. It means the tax bill doesn't disappear when you die. In many cases, it becomes part of your children's tax situation instead.

If leaving money to your family is important to you, that's worth planning for while you still have choices.

03You may be able to change what they inherit

Suppose you're retired and have a large Traditional IRA. Your own taxable income is relatively low for a few years, and you expect some of that IRA to eventually pass to your children.

One option you might evaluate is a Roth conversion. You voluntarily recognize some taxable income now, pay the tax yourself, and move the money into a Roth. Whether that improves the family's overall result depends on your tax rate, your children's likely tax situation, the size and timing of the conversion, how the tax is paid and the rest of your plan.

Another option is simply how you use your own accounts during retirement. If you spend more from tax-deferred accounts during your lifetime and preserve other assets, the mix your children eventually inherit changes.

Life insurance can also play a role in some estate plans. Death benefits are generally received income-tax-free by beneficiaries, but whether insurance makes sense depends on the cost, health, insurability, policy structure and what you're actually trying to accomplish.

1. 01A Roth conversionRecognize some taxable income now, pay the tax yourself, and move the money into a Roth.
2. 02How you use your own accountsSpend more from tax-deferred accounts during your lifetime and preserve other assets, and the mix changes.
3. 03Life insuranceDeath benefits are generally received income-tax-free by beneficiaries, where insurance makes sense for the cost and the purpose.

These aren't three moves everybody should make. They're examples of why legacy planning starts before the assets are inherited.

See what a conversion changes →

04Taxes aren't the only thing to plan

It's easy to turn a legacy conversation into a tax exercise. I wouldn't.

Maybe your goal is to leave as much as possible to your children. Maybe you'd rather help them while you're alive. Maybe one child needs more help than another. Maybe part of the estate is going to charity. Maybe your biggest concern isn't the tax bill at all. It's making sure your spouse is okay first.

Those decisions come before deciding which account is the most tax-efficient to leave behind.

The tax planning should support what you're trying to do for your family, not become the goal by itself.

The tax planning should support what you're trying to do for your family, not become the goal by itself.

05Make it easier on the people receiving it

There's another part of legacy planning that has nothing to do with tax rates.

• Would your children know what accounts you have?
• Do the beneficiary forms match what you actually want?
• Do they know who to call?
• Would they understand why you set things up the way you did?

That's part of the gift too.

You don't necessarily need to tell your children every account balance. But a simple conversation about what exists, how things are supposed to work and who can help them can save a lot of confusion later.

06Start with what you want them to receive

If leaving money to your family matters to you, don't stop at the number on the statement.

Look at what you own, how each asset would pass, what taxes or rules could come with it and whether the result matches what you intended.

You may decide nothing needs to change. You may decide to convert some IRA money over time, spend from accounts differently, use insurance for a specific purpose or give some money away while you're still here to see it used.