the worst asset to inherit
If you've got a traditional 401(k) or IRA and you plan to leave money to your kids, that account may be the worst asset to inherit.
Here's why.
Every dollar in a traditional IRA or 401(k) is money you've never paid tax on. You got the deduction going in, and the tax has been waiting ever since.
When your kids inherit that account, they pay ordinary income tax on every dollar they pull out. And under the current rules, most adult children have to empty the whole thing within ten years.
Those ten years usually land right on their highest-earning, highest-taxed working years.
Now compare that to a house or a regular brokerage account.
When you die, those get a step-up in basis. The gain that built up over your lifetime gets wiped clean. Your kids could sell the day after they inherit and owe little or nothing.
The IRA gets no step-up. None.
The actual numbers: Leave your kids $300,000 in a traditional IRA, and an adult child in the 24% bracket pays around $72,000 in federal tax pulling it out. Leave them $300,000 in a brokerage account or a paid-off house instead, and the basis resets at your death. They can sell and owe close to nothing.
Same $300,000. A $72,000 difference in what actually reaches them.
So the instinct to leave the kids the IRA and hold onto the house is backwards. The house is one of the best things to pass on. The traditional account is one of the worst.
This is also why a Roth conversion isn't only about your own taxes. Convert in your lower-income years, pay the tax at your rate, and your kids inherit money they pull out tax-free instead of a ten-year tax bill.
The asset that feels like the tidy gift is the one carrying the bill.
As promised, income over wealth in under a minute.
- Dan
Here's why.
Every dollar in a traditional IRA or 401(k) is money you've never paid tax on. You got the deduction going in, and the tax has been waiting ever since.
When your kids inherit that account, they pay ordinary income tax on every dollar they pull out. And under the current rules, most adult children have to empty the whole thing within ten years.
Those ten years usually land right on their highest-earning, highest-taxed working years.
Now compare that to a house or a regular brokerage account.
When you die, those get a step-up in basis. The gain that built up over your lifetime gets wiped clean. Your kids could sell the day after they inherit and owe little or nothing.
The IRA gets no step-up. None.
The actual numbers: Leave your kids $300,000 in a traditional IRA, and an adult child in the 24% bracket pays around $72,000 in federal tax pulling it out. Leave them $300,000 in a brokerage account or a paid-off house instead, and the basis resets at your death. They can sell and owe close to nothing.
Same $300,000. A $72,000 difference in what actually reaches them.
So the instinct to leave the kids the IRA and hold onto the house is backwards. The house is one of the best things to pass on. The traditional account is one of the worst.
This is also why a Roth conversion isn't only about your own taxes. Convert in your lower-income years, pay the tax at your rate, and your kids inherit money they pull out tax-free instead of a ten-year tax bill.
The asset that feels like the tidy gift is the one carrying the bill.
As promised, income over wealth in under a minute.
- Dan
