Want to learn the best ways to leave money to heirs tax-free? When someone dies, their estate is typically divided among their heirs. If you are lucky to inherit money or property, you may wonder if you must pay taxes. This guide will provide tax strategies to minimize or avoid paying taxes on an inherited annuity, 401k, and IRA. These tax strategies are perfect for:
- High-income earners and high-net-worth individuals
- Annuity owners plan to leave the funds to heirs.
- Consumers with current or prior health issues want life insurance coverage.
- Seniors up to age 85 want life insurance, paid in a single payment.
- Do consumers want to avoid taxes on Required Minimum Distribution (RMD)?
This guide will answer the following questions:
- Do you pay taxes on an inheritance?
- Do beneficiaries pay taxes on estate distributions?
- How do I avoid paying taxes on an inherited IRA?
- How to pass money to heirs tax-free?
- How can I avoid paying taxes on annuities?
- Do You Pay Taxes On An Inheritance?
- How To Pass Money To Heirs Tax-Free
- Understand Estate Taxes
- Utilize Tax-Free Accounts
- Establish Trusts
- Plan Early and Regularly Review Your Plan
- For the insured wanting to leave money to heirs
- Annuities with Enhanced Death Benefits
- Life Insurance-Annuity Hybrid Plans
- How To Avoid Taxes On An Inherited Annuity
- What Is The Tax Rate On An Inherited Annuity?
- Next Steps
- Frequently Asked Questions
- Related Reading
- Request A Quote
Do You Pay Taxes On An Inheritance?
Are death benefits taxable? Yes, beneficiaries will pay taxes on death with most qualified retirement plans such as an IRA or 401(k). The entire amount left to heirs is subject to taxes (except for a Roth IRA). Any retirement savings funded with after-taxed money are subject to taxes, but only the interest earned is taxable.
Helpful Tip: If you need a cheap service to set up your entire estate plan, we recommend:
How To Pass Money To Heirs Tax-Free
To avoid taxes on inheritance for your beneficiaries, utilize a deferred annuity or a life insurance policy. Annuities offer enhanced death benefits to allow beneficiaries to offset taxes or spread the tax burden over time. Life insurance will also allow the conversion of a tax-deferred status to tax-free status while a policy owner is alive.
Annuity Example
The ClassicMark Fixed Index Annuity offers an optional enhanced death benefit called the Heritage Maximizer that will pay a 30% bonus on the annuity’s total value when the owner dies (see rules and guidelines).
This 30% bonus will pay most, if not all, Federal and State taxes, allowing beneficiaries to collect the proceeds in a lump sum without losing their inheritance. In addition, this annuity is perfect for 401(k) and IRA savings, currently in a tax-deferred status.
The enhanced death benefit is also a solid alternative for retirees who can not purchase life insurance coverage due to pre-existing medical conditions because no medical underwriting is required.
Understand Estate Taxes
Understanding estate taxes is the first step in passing your wealth to your heirs tax-free. Estate taxes are levied on the property transfer from a deceased person to their heirs. The federal government imposes estate taxes on estates that exceed a specific value. In 2023, the exemption amount is $12.06 million, meaning an estate worth less than this amount is not subject to estate taxes. However, if your estate exceeds this amount, you must plan to minimize estate taxes.
Utilize the Annual Gift Tax Exclusion
One way to minimize estate taxes is by utilizing the annual gift tax exclusion. The annual gift tax exclusion allows you to gift up to $15,000 per recipient per year without incurring gift tax. For example, if you have three children and five grandchildren, you can gift each $15,000 yearly, totaling $120,000 annually, without incurring gift tax.
Consider Charitable Donations
Another way to minimize estate taxes is by making charitable donations. Charitable donations are tax-deductible, meaning you can reduce your estate taxes by donating a portion of your estate to a qualified charity. Additionally, you can set up a charitable trust to provide you with income during your lifetime while reducing your estate taxes.
Utilize Tax-Free Accounts
Another way to pass on your wealth tax-free is by utilizing tax-free accounts. There are several types of tax-free accounts that you can use to pass on your wealth to your heirs, including Roth IRAs, 529 plans, and Health Savings Accounts.
Roth IRAs
Roth IRAs are an excellent option for passing on wealth tax-free. With a Roth IRA, you contribute after-tax dollars, and your earnings grow tax-free. In addition, when you withdraw funds from a Roth IRA, you do not incur taxes; your heirs can also withdraw funds tax-free. This makes Roth IRAs an ideal option for passing on wealth to your heirs tax-free.
529 Plans
Five hundred twenty-nine plans are another tax-free account that you can use to pass on wealth to your heirs tax-free. With a 529 plan, you can contribute up to $15,000 per year per beneficiary without incurring gift tax. In addition, theIn addition, theIn addition, theIn addition, theIn addition, theIn addition, the earnings in a 529 plan grow tax-free, and when you withdraw funds to pay for qualified education expenses, you do not incur taxes.
Health Savings Accounts
Health Savings Accounts (HSAs) are also an excellent option for passing on wealth tax-free. With an HSA, you contribute pre-tax dollars, and your earnings grow tax-free. When you withdraw funds to pay for qualified medical expenses, you do not incur taxes, and your heirs can also withdraw funds tax-free.
Establish Trusts
Another way to pass on your wealth tax-free is by establishing trusts. Trusts are legal entities that allow you to transfer assets to your heirs while minimizing taxes.
Irrevocable Life Insurance Trusts
One type of trust you can use to pass on your wealth tax-free is an Irrevocable Life Insurance Trust (ILIT). With an ILIT, you transfer your life insurance policy ownership to the trust, which pays the premiums. Then, when you pass away, the death benefit is paid to the trust and is not considered part of your estate, which means it is not subject to estate taxes. The trustee can then distribute the funds to your beneficiaries tax-free.
Grantor Retained Annuity Trusts
Another type of trust that you can use to pass on your wealth tax-free is a Grantor Retained Annuity Trust (GRAT). With a GRAT, you transfer assets into the trust and receive an annuity payment from the trust for a set number of years. Then, when the trust term ends, the remaining assets are tax-free to your beneficiaries.
Plan Early and Regularly Review Your Plan
The final tip for passing on your wealth tax-free is to plan early and regularly review your plan. Estate planning should not be a one-time event. It is essential to review your plan regularly and make updates as needed. This will ensure that your plan remains up-to-date with any tax law changes or circumstances.
For the insured wanting to leave money to heirs
Here are a few tips if you’re researching ways to proactively want to leave your beneficiaries’ inheritance and reduce their tax burden. These strategies apply to qualified retirement plans such as 401k, IRA, and annuity accounts.
Note* If you are healthy, purchase life insurance first, then consider these tax strategies.
Annuities with Enhanced Death Benefits
Generally, annuities avoid probate, which automatically is not included in the deceased’s estate (if set up correctly), but how do you avoid paying ordinary income taxes?
Some annuities offer a life insurance alternative called Enhanced Death Benefits. These benefits are designed to maximize a death benefit without the medical underwriting required for applying for life insurance.
By utilizing these enhanced death benefits, your heirs would either
- spread the tax burden over time,
- pay fewer taxes overall, or
- Cover their tax bill entirely.
Life Insurance-Annuity Hybrid Plans
Generally, life insurance provides tax-free proceeds to beneficiaries but accepts only after-tax money, but what about qualified retirement plans such as an IRA or 401(k)? This is where life insurance-annuity-hybrid plans come into play.
The life insurance annuity plan consists of two contracts:
- A single premium immediate annuity (SPIA)
- A life insurance policy.
Converting Annuities, 401k, and IRA to Life Insurance
The payments from the SPIA will go directly to the life insurance policy. This process lets the insured spread the taxable income in the funds used to purchase the SPIA over a 5,7, or 10-year period. The result leaves a tax-free death benefit for your beneficiaries on Day 1.
- These hybrid plans can also fulfill RMDs for your IRA or 401(k).
- The life insurance coverage is guaranteed on Day 1 and will not lapse as long as the hybrid plan is not canceled.
- Some life insurance annuity plans will offer tax-free life insurance proceeds and the remaining payouts if the insured dies before the payout ends.
The Application Process
- Please request a quote from us below.
- Submit an application and health questionnaire.
- Conduct a 20-minute phone interview with a medical underwriting team.
- Wait up to 48 hours for approval. Typically, the approval rate is high; the decline rate is low.
- If approved for life insurance coverage, transfer the funds.
- You’ll receive a 1099 form to report the annual SPIA payment to the IRS.
How To Avoid Taxes On An Inherited Annuity
The Surviving Spouse
Suppose a surviving spouse recently inherited an annuity. In that case, they can either pay taxes on the funds, spread the tax payment over time, or exercise the spousal continuation provision. Spousal continuation is the tax strategy to avoid paying taxes now.
Non-Spousal Beneficiaries
Suppose a non-spousal beneficiary inherits money, an annuity, or a qualified retirement plan without the benefits mentioned. In that case, they can utilize a new bonus annuity to help offset the tax burden.
What Is The Tax Rate On An Inherited Annuity?
Typically, inherited annuities are taxed at the ordinary income tax rates of the beneficiary.
Next Steps
To avoid taxes on inheritance, you can use a deferred annuity or a life insurance policy. Annuities offer enhanced death benefits, allowing beneficiaries to offset taxes or spread the tax burden over time. Life insurance will also allow the conversion of a tax-deferred status to tax-free status while a policy owner is alive. Request a quote, and let us help you find the best way to protect your loved ones from excessive taxation.
Request A Quote
Get help from a licensed financial professional. This service is free of charge.
Frequently Asked Questions
How do I transfer wealth to a family without paying taxes?
Gifting is the answer! The annual gift tax exclusion offers an easy and efficient approach to minimizing estate taxes while allowing you to shift income toward your heirs. Other techniques such as direct payments, loans given to family members, Grantor Retained Annuity Trusts (GRAT), and Roth IRA conversions can all be utilized in this endeavor – with help from an expert Tax Professional if necessary.
How do I gift a large sum of money to my family?
You can do this quickly and safely in numerous ways, such as writing them a check or wiring funds between accounts. Additionally, if the amount given is less than $17,000 per year for each family member, there will be no need to file gift tax returns. However, if it’s over that threshold, it still easily keeps track of donations -simply allowing you to file the necessary documents when needed.
Can I gift $100 000 to my son?
Have you ever considered gifting your son a large sum of money? Fortunately for you, the federal government has set a limit on lifetime gifts at $11.7 million per person ($23.4M combined for married couples). This means that if you wanted to gift up to 10 million dollars today – without any tax implications attached – it is 100% possible!
Do you have to report cash inheritance to IRS?
Generally, you do not need to include your inheritance in your taxable income. Nonetheless, should the inheritance be regarded as an income related to a decedent, then taxes may apply.
How much can you inherit from your parents without paying taxes?
California residents do not need to stress – the state does not collect estate or inheritance tax. Moreover, only a handful of states require people who inherit money to pay an inheritance tax by 2023. So you can rest easy knowing that your inheritance is free from taxation!
Do beneficiaries pay taxes on inherited money?
Generally speaking, no. With exception to retirement accounts (such as a 401(k), 403(b), or IRA), life insurance proceeds, and savings bond interest, the beneficiary usually will not have to bear any income tax on their inherited wealth. However, if any of these funds were initially deposited with tax deductions in mind, those particular earnings are taxable when received by the beneficiary.
Related Reading
- Annuitant vs. Beneficiary: What’s The Difference?
- Primary vs. Contingent Beneficiary: What’s the Difference?
- What Happens To A 401K When You Die?
- Inherited Annuities: What Are My Options?
- Annuities that offer a Death Benefit to Beneficiaries
- The Complete Annuity Death Benefit Guide
- The Best Annuity Death Benefits
- What is Spousal Continuance?
- How to Retire on $200,000 Inheritance
*Disclosure: Some of the links in this guide may be affiliate links. I may receive a commission at no cost if you purchase a policy. It helps us keep the lights on!