Leave Your Loved Ones a Generous Legacy — Not a Tax Bill

One of the most important things you’ll have to consider when drawing up a comprehensive financial plan is how you want to live in retirement.

Ironically, a vital part of that discussion will be deciding what you want to happen when you die.

Many Baby Boomers want to leave money to their children and, like their parents and grandparents before them, are willing to live a diminished retirement to do so. It’s an honorable intention — giving up some of the things you might want so your loved ones can have more. But in many cases, it may be unnecessary.

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With smart, tax-efficient financial planning, you should be able to enjoy your money during your lifetime and also leave a generous legacy to your family and/or favorite charity.

If you want to leave as much money as possible to your loved ones, a proper financial plan should ensure that your hard-earned assets will go to the people you care about most in a tax-efficient manner and with the least amount of expense or delay. While I’m not an estate-planning attorney, I recognize the value of having a relationship with legal professionals who can provide crossover services for your financial strategy. And that especially includes help in developing legacy strategies for the largest asset for many Baby Boomers: their tax-deferred retirement accounts.

Your 401(k), 403(b), IRA or other qualified plan can become one of the most valuable assets you leave to your loved ones. But without proper planning, it also can become a large tax burden, and it takes some proactive efforts to ensure that your gift doesn’t cause problems down the line.

Let me give you a hypothetical example. Say we have a husband and wife, we’ll call them Joe and Sue, and they have two children and four grandchildren. Joe dies, leaving his entire $1.5 million IRA to Sue, his primary beneficiary.

Because she’s over 70½, accepting the inheritance usually triggers a required minimum distribution (RMD), which means more taxable income for Sue. But what if she doesn’t need the IRA assets? What if she has sufficient income elsewhere and would rather let the IRA money grow for future generations?

Well, thanks to IRS gift tax section 2518, Sue’s financial adviser and attorney would probably steer her to “disclaim” the property. What this means is that, within nine months of Joe’s death, Sue can decide whether to accept the inheritance or pass it on. If she files the disclaimer in those nine months, she will let all or part of the IRA pass directly to her children and grandchildren, the contingent beneficiaries specified on Joe’s IRA.

With the qualified disclaimer, Sue can save on taxes for both herself and her children, because the children will only be required to take RMDs at rates determined by their own life expectancy table. They’ll have much lower RMDs than Sue would have had.

I see retirees all the time who let money sit in their retirement accounts so they’ll have some kind of legacy — and they haven’t even considered the tax consequences to themselves (in the form of RMDs) or their children. Or they’ll take their RMDs starting at 70½ and put the money in a bank account or a certificate of deposit that earns 1% or so, not realizing that there are many options that might better fit their needs.

That’s one reason it’s important to work with a team of professionals who understand those options, their pros and cons and ins and outs. Just remember, when it comes to tax and estate planning, the devil is in the details.

• It’s important that you annually verify and update the beneficiaries you’ve designated to your IRA. The IRA beneficiaries listed there will take precedence over any will or living trust that dictates the disposition of your retirement assets at death.
• If you make a qualified disclaimer, you must do it within nine months of the date of death. That may seem like a long time, but it can be a complex process, and one that should be done with an attorney who can answer any questions about IRS gifting limitations or other estate-planning needs.
• A good financial adviser who is a fiduciary will act in your best interests in all aspects of retirement planning. Make sure your financial professional is knowledgeable and experienced in the issues that could affect your retirement plan.

Retirement planning doesn’t end on the day you stop working. It’s important to work closely with your financial, tax and legal professionals before and during your retirement years to develop strategies that evolve with you and your changing needs and goals.

Kim Franke-Folstad contributed to this article.