Death, Taxes and IRAs

IRAs are taxable after you die.

When people talk about “death” taxes, they usually mean “estate” taxes.  Now, for 2016, there is no federal estate tax if your estate is under $5,450,000.  So for most people, you don’t have to deal with estate tax.  But IRAs are a different animal!

 

An IRA is considered to be taxable income.  So – if you die, your beneficiary will have to pay tax on that IRA money.  So, maybe you don’t care – since you’ll be dead anyway.  But if you do care about leaving a taxable legacy to your heirs, here’s a few things to think about.

 

1.  Roth IRAs are not taxable.  Not to you, not to your heirs.  (I always like Roth IRAs.)

 

2.  A lot of people sign up for IRAs but they don’t know who the beneficiary should be (or they don’t have all the information they need to complete that part of the paperwork.)   When they sign up they just put “estate” down in the beneficiary box.   This is usually a bad thing.  What happens is that your heirs wind up having to file a form 1041, an Estate and Trust tax return.  Now, if you Google “estate tax” you’ll probably find all the tax rates on estates – and you’ll read the tax brackets for if you have over $5,450,000.   (And that’s a form 706 – it’s a different animal.)

 

The 1041 form for income tax on estates and trusts is for the income earned by the estate – which includes your IRA income.  The first $2,500 is taxed at 15%, the next bracket up to $5,900 is taxed at 25%, the next bracket up to $9,050 is at 28%, then up to $12,200 is at 33%, and anything over that is $39.6%.  It doesn’t take a whole lot of money to kick your IRA income into the top tax bracket!  Just to give you a comparison – a single person won’t hit the 39.6% tax bracket until he or she reaches $415,050 in taxable income.

 

So what does this mean?  Well, if your heirs aren’t rich, they’re going to be better off if they inherit your IRA directly from you instead of from your estate.

 

3.  If your goal is to leave a legacy to your children – life insurance is better than an IRA.  (I can’t tell you how much I hate sounding like a life insurance salesman but it’s true.)  Your IRA is your retirement account – it’s supposed to be money for you to spend during your retirement.  In a perfect world, you spend it all before you die.  (And of course, have enough to enjoy a long and happy retirement.)  Life insurance provides your loved ones with tax free cash after you die.

 

This is really a personal decision on your part.  Do you want to leave something for the kids or not?   For some people that’s a major priority, for others, not at all.  It’s your choice.  But not matter what you decide, be sure to work with your financial advisor to make sure your heirs are properly listed as beneficiaries to your taxable retirement accounts.