The Inheritance Challenge

Some inherited assets are tax-friendly, but under new rules, others come with a hefty tax bill. We help you get the most out of a legacy.

- By Sandra Block

UNLESS YOU SPEND YOUR WINTERS IN ASPEN and your summers in the Hamptons, you probably don’t have to worry about paying federal estate taxes on an inheritance. In 2021, the federal estate tax doesn’t kick in unless an estate exceeds $11.7 million. The Biden administration has proposed lowering the exemption, but even that proposal wouldn’t affect estates valued at less than about $6 million. (Some states have lower thresholds, however; see the box on page 58.)

But if you inherit an IRA from a parent, taxes on mandatory withdrawals could leave you with a smaller legacy than you expected. And as IRAs become an increasingly significant retirement savings tool—Americans held more than $13 trillion in IRAs in the second quarter of 2021—there’s a good chance you’ll inherit at least one account.

NEW RULES

Before 2020, beneficiaries of inherited IRAs (or other tax-deferred accounts, such as 401(k) plans) could transfer the money into an account known as an inherited (or “stretch”) IRA and take withdrawals over their life expectancy. This enabled them to minimize withdrawals, which are taxed at ordinary income tax rates, and allow the untapped funds to grow.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 put an end to that tax-saving strategy. Now, most adult children and other non-spouse heirs who inherit an IRA on or after January 1, 2020, have just two options: Take a lump sum or transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner.