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What to Bequeath

YOUR HEIRS WILL likely appreciate what you bequeath them. But some bequests may be appreciated more than others.

At the top of the list would probably be a Roth IRA. Yes, estate taxes could be owed if your overall estate is large enough and, yes, your heirs will have to draw down the account gradually over their lifetime—and possibly within five years if the stretch IRA disappears. But there will be no income taxes owed on those withdrawals, and the money that remains in the account can continue to grow tax-free.

Life insurance can also make an attractive inheritance, especially if you are subject to estate taxes. Why? The proceeds will be income-tax-free to your beneficiaries and, if properly structured, the policy won’t be part of your taxable estate. Still, given how expensive life insurance becomes as you age, you probably shouldn’t buy it solely to ensure an inheritance, unless estate taxes are an issue.

You might keep highly appreciated investments held in a regular taxable account and bequeath those. That way, you’ll avoid the embedded capital gains tax bill, thanks to the step-up in basis upon death, and that will leave more money for your heirs. In 2015, President Obama proposed eliminating the step-up. Even though the proposal didn’t become law, it’s an idea that may be revived at some point. Keep in mind that you should sell underwater investments, not bequeath them. You can use the tax losses to reduce your income tax bill while you’re alive, but those losses have no tax value after your death.

What if you are faced with a choice between bequeathing a traditional retirement account and bequeathing money in a taxable account? If the stretch IRA survives, the traditional retirement account might make the better inheritance, especially for younger beneficiaries and those in low tax brackets. But if the stretch disappears, money in a regular taxable account will mean more after-tax dollars for your heirs.

Finally, your heirs will probably be less happy to inherit assets that are difficult to sell. At issue here are not only illiquid investments, but also time shares, antique cars and second homes. Clearly, if you’re making full use of these assets while you’re alive, you should keep them. But your heirs would probably prefer to receive cash.

Next: Trusts

Previous: No More Stretch?

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