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The Tax-Smart Way to Leave Money to Your Heirs and to Charity

From 401(k)s and IRAs to stocks and bonds, your retirement savings accounts are taxed in different ways. So to make the most of your money, it makes sense to pass certain types of accounts to family and others to charity.

Do you want to leave a legacy to your family and your favorite non-profit? It’s a great idea that can benefit a lot of people — even more so if you do it right in terms of taxes.

Taxes apply differently to various types of investment accounts. For example, IRAs, 401(k)s and some other types of accounts are tax deductible at the front end. They are wonderful accumulation vehicles because they allow your money to grow without being taxed. But distribution is another story. Money withdrawn from those accounts can be considered ordinary income, which incurs the highest tax.

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In contrast, non-retirement plans (non-IRA accounts) don’t help you to accumulate quite as much money, because you pay taxes on dividends and capital gains as they grow. The tax benefit to these accounts comes upon your death, when their worth is calculated using a “stepped-up basis.”

What’s a stepped-up basis? To begin with, the IRS defines basis as "the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also use it to figure gain or loss on the sale or other disposition of property." When using a stepped-up basis, the value of the account is not determined by the amount of money you originally paid for it, but by its worth on the date of your death.

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For example, let’s say 30 years ago you bought a stock for $100, and it is now worth $100,000. If upon your death, your heirs sold it for $100,000, they would have no gain. Even though you made $99,900 on that lucky investment, since the date of death value ($100,000) is their basis, they made no profit and pay no taxes.

As you can imagine, your heirs would probably prefer to inherit non-IRA accounts, because they won’t be taxed. Qualified charities, on the other hand, don’t care which type of account you leave to them. Why? As non-profits, they won't pay taxes on any legacy you leave them.

So, if you want to leave money to your family and donate to charity, talk to a professional about willing your non-IRA taxable account to your heirs and your IRA to a non-profit, to maximize the good your financial legacy can do.

About the Author

Ken Moraif, CFP®

CEO and Senior Adviser, Retirement Planners of America

Ken Moraif, CFP, is CEO and senior adviser at Retirement Planners of America, a Dallas-based wealth management and investment firm with over $4.3 billion in AUM and serving over 8,000 households (as of May 2019). He is also the host of the radio show "Money Matters with Ken Moraif," which has offered listeners retirement, investing and personal finance advice since 1996.

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