What’s the Best Strategy to Bequeath an IRA?

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By Enrolled Agent Steven J. Weil, Ph.D., President, RMS Accounting

As 2017 draws to a close, it may be a good time to take stock of your assets and review your plans for their disposition.

Let’s review what choices you have for a traditional IRA or a Roth IRA and whether it makes sense to leave either of them to your loved ones:

Consider that an IRA may be subject to double or even triple taxation because:

• A  traditional IRA could be taxed as part of your estate.

• Further, the taxable portion of the IRA balance (sometimes the entire balance) is considered income, which means that when IRA withdrawals are made by the recipient, they are taxed.

• In addition, state income tax also may be due.

Those three taxes can reduce the amount that is left to an heir while tax collectors benefit most.

The Solution May Be Leaving the IRA to Charity Instead

Consider naming your favorite tax-exempt charitable organization as the beneficiary of your IRA, and, at the same time, leave other assets that will have a higher after-tax value to your heirs. This option is very tax efficient and avoids double or triple taxation because an IRA balance that is left to charity is not considered part of your estate and, therefore, is not subject to the estate tax. Nor is it subject to federal or state income tax.



There is yet another option to consider, but it may not be as efficient:  Take money out of your IRA now and pay the taxes due.  Then donate cash to charity, which is fully deductible, except for possible income-based restrictions that may limit the amount of your charitable deductions.  In that case, you can choose to claim the deductions over a period of years.

Should You Leave a Roth IRA to Charity? 

The answer here is generally “no.”  A smarter alternative is to leave Roth balances to designated beneficiaries because there’s a tax break if the Roth IRA has been open for more than five years before withdrawals are taken: they are then tax free.  It is important to note, however, that the specified five-year period begins on January 1st of the year the initial contribution or conversion was made to the Roth IRA.

The Step-Up Option

Finally, there is a strategy that allows you to leave more to your favorite charities, more to your loved ones and less to the tax collector.  You can make bequests to loved ones by leaving them gifts such as common stocks and mutual fund shares held in taxable investment accounts, business ownership interests, real estate and whatever qualifies for capital gain treatment when it is sold.

Such gifts are eligible for the federal income tax basis “step-up” to fair market value, as of the date of your death. Your heirs may then sell these assets with little or no income tax. Post-death appreciation would be taxed; and, assuming your estate is taxable, these assets also will be included in your estate and incur federal estate tax.

You can generally use this strategy with other types of tax-deferred retirement plan accounts that have specific balances, e.g. 401(k), corporate profit-sharing, or SEP and Keogh retirement accounts.  However, state law may require a married filer to obtain their spouse’s permission to name charities as beneficiaries of these accounts.

It always best to consult your tax advisor in order to take advantage of opportunities to potentially minimize federal and state income taxes as well as estate taxes.

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