Think About the Tax Consequences of Distributing Your Assets

Posted by Harvey L. CoxJul 01, 20210 Comments

Example:  Mary's estate consists of two significant assets, a life insurance policy and a traditional IRA.  Both assets are equal in value.  To simplify and equally distribute her assets, Mary names her son as the beneficiary of her life insurance and her daughter as the beneficiary of her IRA. 

What is the problem with Mary's plan? 

The problem is how the plan ultimately distributes the assets to Mary's children.  The proceeds of life insurance are income tax-free. Mary's son gets the full value of her life insurance.

The proceeds of Mary's IRA, however, are subject to income tax.  Mary's daughter will lose about one-third of the value of the IRA to income taxes.

Mary's attempt to divide her primary assets equally to her two children doesn't work.

This example illustrates why I discourage clients from leaving specific assets to specific persons.  A better option is to name all children as beneficiaries with equal interest.  The best solution, however, is to transfer all assets to a Living Trust.  The trust then divides assets equally to the children and specifies what to do with assets should a child predecease you.