In this Episode of the Secure Your Retirement Podcast, Murs and Taylor Wolverton, Director of Financial Planning and Tax Strategy, discuss how the most common assets are taxed when they pass to your heirs. They separate federal estate tax and state taxes from the income tax most heirs face. Then they work through cash, brokerage accounts, IRAs, Roth IRAs and real estate one account at a time.

Listen in to learn about how step-up in basis can erase decades of capital gains, and why the 10-year rule makes an inherited IRA a planning project. They also explain how small Roth conversions today can grow into a meaningful tax-free inheritance for your kids.

In this episode, find out:

• The difference between estate tax, inheritance tax and the income tax most heirs pay
• Why inherited cash carries no income tax, and how a payable-on-death designation keeps it out of probate
• How step-up in basis works on inherited stocks and real estate, and what changes if you keep holding
• How the 10-year rule and yearly required distributions apply to inherited traditional and Roth IRAs
• The two-year home-sale window for a surviving spouse, and why an appraisal at death matters

Tweetable Quotes:

“Your estate is really everything you leave behind.” Taylor Wolverton

“We’re not here to try to sell anyone on anything. We enjoy planning, we like solving the puzzles.” Murs Tariq

Audio check needed before publishing. Both quotes need verifying against the recording. The Murs line is lightly cleaned of filler words from the transcript.

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary phone conversation with Secure Your Retirement!

Here’s the full transcript:

So, Taylor, thanks for joining me today. you know, I think with us in in what we do at our firm and talking about taxes all the time, we get a lot of questions around inheritance tax. And I think inheritance tax is something that gets confused quite often, even for advisers and people that work in this business. and I think it’s it’ll be nice today to really talk through, implications around inheritance, right? ’cause you’ve got, you know, people inheriting property, you’ve got people inheriting cash from the bank, they’ve got you’ve got people inheriting, retirement accounts like IRAs and Roth accounts. And they a lot and then and then brokerage accounts and, you know, those stocks and everything. So, it seems like every single one of them has a different rule and then people are always asking about this thing called estate tax and that throws in another layer of confusion. so I think today, it if we can try to make it, and for the listeners, we’ll try to make this as easy to digest as possible, realizing that this is not a very simple topic. But the good news is is, is Taylor knows a lot about this, and she knows how to talk to people in a normal way, too, which is why we love having her on the podcast and why a lot of clients give us so much positive feedback around their interactions with her. So, Taylor, again, thanks for being on and helping us kind of understand inheritance taxation. of course. All right, so then let’s just dive in. Why don’t you give us a an overview of the types of tax that are out there so we can kind of set the foundation and then we’ll go into different types of accounts and what people are thinking about around inheritance. Yes, and I think this is a part that does get easily confusing because there are different types of taxes that your inheritance can be subject to. The first one is federal estate tax. And this is, at least among our clients, rare that it applies because federal estate tax is only on estates that are larger than $15 million dollars per person or if you have a couple, then that’s $30 million combined. That $15 million is subject to change. That’s what it is right now according to tax law. But if a person was to pass away with an estate larger than that amount, then the amount over that $15 million exemption is subject to estate tax paid by the estate. The rate The tax rate ranges from 18 to 40%. So, it is pretty steep. It climbs up to that 40% quickly. But it is rare because of that exemption, the $15 million exemption that’s in place right now, that anyone really has to worry about estate tax. That’s on a federal level. Some states also have an estate tax that applies. North Carolina does not. So, that’s also rare amongst our clients anyway. Most of them are in North Carolina, so you don’t have to worry about federal estate tax or state estate tax. There are also inheritance taxes that some states subject the beneficiaries to as well. Again, North Carolina is not one of those states, so we don’t have to worry about inheritance tax. That would be what the beneficiary of the estate has to pay on their inheritance to the state that they live in. But, the most common tax and the one that most inheritors are worried about and that applies to most of our clients that we talk about is just your regular income tax. Then, you have to pay any every year ’cause you have income anyway, and then parts of your inheritance at times can be subject to income tax. So, that’s what we’re going to talk about mostly today is income tax. Great. So, real quick before we go into that, can you maybe just define, you know, what what makes up an estate? So, what types of assets are going to go into the estate that are going to be subject to? When I say “subject to,” that doesn’t mean it applies; it just means it’s in a category where it could be taxed. But again, like you just said, you really have to have 15 million as an individual or 30 million as a family more than that to be subject to estate tax. But, what’s an estate in a nutshell? Right. Your estate is really everything you leave behind. All of your account balances, your retirement accounts, your savings accounts, your CDs, your real estate, your primary home, and then any other properties or land that you have, even life insurance proceeds. Basically, all the dollar values to your name, that all gets combined in your estate. Perfect. So, if we add all those up and it’s below 15 million, then very likely you’re in a place where you’re not worried about estate taxation, right? Yes. And so, if you if you add all those up as a listener and you are in a place where it’s a it’s totaling above 15 million as a single person or 30 million as a couple, then there’s some other advanced work that you would want to be thinking about, and that that would be a whole separate conversation. there are some strategies out there to to help manage if you are above that threshold your estate taxation. and so we would encourage a conversation on that off the podcast, obviously. but Taylor, let’s go into kind of let’s just break it down by types of accounts or types of assets. You know, we talk about we talk a lot on this podcast about buckets. We talk about buckets in the sense of your investment buckets of cash, safety, and growth. But also there’s tax buckets, too, of of you know, taxable accounts, tax-deferred accounts, and really tax-free accounts. And so why don’t we just start off with the most common, which is you know, anyone that’s leaving behind cash and bank accounts, how does that type of transition on inheritance work? bank accounts most common and fortunately the most simple to understand as far as taxation because if you inherit cash in a savings account, checking account, CD, whatever vehicle, if it’s cash, you will not pay income tax on that balance when you inherit it. So let’s say my mom passes away, she leaves me $50,000 in a checking account balance, I receive that $50,000 as a beneficiary, I do not pay any income tax on my $50,000. Done. Perfect. So very easy easy one to inherit. I’ve got that question all the time. Hey, I just inherited you know, a couple hundred thousand dollars and the first thing I ask is what type of account did it come from? And they said, “Oh, it was just from a bank account.” And I say, “Perfect. There is no taxes where to worry about there. All of that 200,000 is yours.” and just one thing on that too, because bank accounts, if you do not have a beneficiary tied to that bank account, it will have to go through probate, if it’s also not titled in the name of a trust. So, from like a potential action item, if you don’t have a payable on death or a transfer on death attached to your bank accounts, that may be something you want to go to your credit union or your bank, or wherever your cash is held, to ask about. Because you want to make sure when you pass away not only thinking about this as a person who is potentially inheriting, but for your legacy as well when you pass away, you want to have that payable on death or that transfer on death designation on your bank accounts to avoid probate and to get that money to the people that you want to inherit. So. I think that’s a really big big point of making sure in general all of our beneficiaries are in line, but a lot of times people don’t think about adding beneficiaries to their checking and savings accounts. and and it just makes everything so much easier on that transition. All right, let’s move into then, an another common type of account, which would be, you know, I had some money laying around in the bank and I decided I wanted to invest it and I opened up a brokerage account at Charles Schwab or Fidelity or Vanguard and, I bought that Nvidia stock, right, that everyone loves and it’s grown so much; it’s got a bunch of capital gains in it. And then I pass away and I’m leaving behind a million dollars of in Nvidia stock in a taxable brokerage account to my son. and let’s say I paid 500,000 for it in this example. Help me walk through how my son is going to inherit that that account. Yes, okay, so you paid $500,000 for the Nvidia stock. When you pass away, it’s worth a million dollars. That difference between what you bought it for and what it’s now worth is your appreciation or your capital gain. What happens with securities like stocks, ETFs, mutual funds, those types of things that are in your brokerage account, the basis gets stepped up when you pass away, which means the value that you bought it for is equal to the value when you pass away when the the son or whoever inherits takes ownership of that. So, when I inherit stock, mutual fund, ETF, whatever, there is no tax immediately on the value of that security at the time that I inherit it. Because the basis immediately gets stepped up. That eliminates any capital gain or appreciation that has taken place when the original owner held that security. The only thing you have to worry about or think of for income tax with securities in a brokerage account is if you continue holding it, then any appreciation that takes place from the time you inherit it to the time you sell it, that appreciation is subject to income tax. So, if you inherit it right away, or you inherit it and then you sell it right away, no tax implications at all. Only if you continue to hold it and it continues to appreciate after your initial value at inheritance. Okay, great. So, I I actually just I just got out of the a meeting with not a client, but someone that’s interested in what we do in one of our evaluation meetings and before I hopped in here with you on the podcast. And I had to explain to her about step-up in basis and she was kind of very excited to learn about this this tool or this this strategy or, you know, allowance that’s in the in the tax code right now. And it made a lot of her stresses go away about potential taxation to her heirs because of this understanding of step-up in basis. So, let me say it back to you, right? So, I bought Nvidia for 500,000. It’s worth a million today. If I was to sell it, the 500,000 myself would the the gain there would be taxed to me at long-term capital gains within that 15 to 20% window. But if I hold on to it, and then something happens to me on my drive home today, and my son inherits, the million dollars of capital I’m, I’m sorry, the million dollars of Nvidia stock you’re saying this step-up in basis: the basis is my 500,000, but it gets stepped up to the market value, which today is a million dollars, on his inheritance. And so, theoretically, he could turn around and sell it right away for a million dollars. His basis is a million dollars, so there’s zero capital gains tax. He just got a million dollars of cash completely tax-free. Yes. Now, if he was to say, “No, I love Nvidia stock and I’m going to continue to hold it.” And say it grows to a million and a half, and he then decides to sell it, what’s he going to deal with there? The appreciation from a million to a million and a half, that $500,000 value, is going to be taxable to him at long-term capital gains rate. So, that same 15 or 20% income tax rate he will pay on the appreciation at the time of sale. So, I think an an important thing to think about here is: if you are listening and you are, you know, going through probate for someone that you, you know, a parent or something like that, or you’re inheriting some assets, a lot of times we end up inheriting what we would call concentrated positions, right? I didn’t want to sell my Nvidia stock because it would cost me too much in tax, and so I decided to let someone else inherit that. It erases the tax, and so there’s a there’s an opportunity that arises on this step-up in basis to where now, you know, my son could sell that million dollars of Nvidia stock completely tax-free and now have the opportunity to diversify away from that. whereas I felt like I was handcuffed to it because it’s done good for me, but now to diversify away, I’ve got a lot of tax implications to deal with. So, keep that in mind if you’re working through an in or something like that or you know you’re going to inherit some money, there is some strategy around at when that inheritance does happen, what do we do next? okay, great, Taylor. So, moving along then, into what is, I think, the most common and and usually the large a larger accounts for most people is going to be in these accounts that we’ve been building up over time in that pre-tax type of bucket or that tax-deferred bucket of traditional IRAs and 401(k)s. these rules, I know, have changed over the years, but it is what it is today. So, help us understand how this one works. exactly. With traditional IRAs, the original owner of that account did not pay tax on that balance. So, as the person who inherits that balance, that tax liability gets passed on to you, as well. So, when you inherit a traditional IRA, according to current tax law, which it did change in the last few years, and who knows, could change again, I don’t know. But, right now, there is what is called the 10-year rule. So, if you when you inherit a traditional IRA, assuming you are not the spouse of the original account owner, you have 10 years to empty that account balance. So, if I inherit a traditional IRA in 2026 from my mom, let’s say, I have until December 31st of 2036, 10 years from now, to get that account balance down to zero. There is a second rule, as well. If the original owner of the account is over their age that they have to take their required minimum distributions, which right now is 73, then you, as a beneficiary, also has to take minimum distributions every year, and are subject to the 10-year rule. So, again, let’s say I inherit a traditional IRA from my mom. My mom is 80, let’s say, when she passes away, I have to take minimum distributions from that account. I could take more than the minimum if I want to, but I have to take at least a minimum every year. And in year 10 after I inherit it, that account balance needs to be zero dollars. and I think this one is another one that we’re constantly having to strategize around, right? So like take someone that So the So let’s just say it’s a million dollars. A million dollar IRA Taylor that you just inherited from your mom. She was of the age of 80, so she was taking required minimum distributions, which means based off the rule, now you’re going to have to take minimum distributions, but there there’s a whole formula around that. Let’s not worry about the formula. So you have to take a minimum, but also you’re subject to So there’s rule number one of taking the minimum, but there’s rule number two of you have to clean out the account in 10 years. And so, theoretically, or you know, if we wanted to do it evenly, you would take a hundred thousand dollars every single year, add that to your taxable income on top of your other earnings and wages, and pay the tax on it with the goal of that clearing it out 10 years from now. Where the strategy starts to come into play a little bit is, you know, well, maybe you’re going to retire in two years from now, and your income is going to go basically down to zero. And so it could make some sense maybe to only take the minimum for the first two years because you’re working and earning, and you’re already in a tax bracket that’s not advantageous. Why add to it now when you’re going to retire in two years, your income goes to zero, and then you you have eight years remaining to clear out that, you know, roughly million dollars, right? That’s one way that we would think through it. but at the end of the day, it it’s changed. It used to be that you could do it over your lifetime. and there’s still certain, you know, exemptions that allow for that. We don’t need to get into that. I think most people are going to fall into the 10-year rule, and you need to be aware of that. And you know, what what is there is there still a penalty if you were to miss anything around, you know, your minimum distributions like there are on if you’re living and you miss a required minimum distribution? Yes, there are penalties, so it is important to pay attention to your required distributions and make sure that you are taking them because those are enforced. I want to say it’s like 25% of the amount if you miss it or something like that, and you have time to remedy it, and there are ways that you can ask the IRS for a waiver of the penalty. But, I could be wrong in that percentage of the penalty; but yes, it is important to make sure you are taking those distributions. You don’t want to have to pay penalties on top of the taxes you already owe on those balances. Right. So, big picture again, if you are in this place of inheritance and, depending on what type of account it is, you, you definitely want to strategize and kind of have that built into your financial plan so that you don’t make any mistakes or don’t pay any more tax than you already have to. and so so, you know, just be aware of that. Moving into one of our favorite, I know one of your favorite types of accounts, Taylor, is the Roth IRA. The Roth IRA is a tax-free account. and so, how does that one work on inheritance? Yes, withdrawals from a Roth IRA as someone who inherits that balance, you will not pay any income tax on those distributions. Roth IRAs are still subject to the same 10-year rule as traditional IRAs. So again, if I inherit a Roth IRA balance in 2026, I need that account balance to be zero by December 31st of 2036. But there is no minimum annual distribution or anything like that. If you wanted to, you could leave that account balance as is, let it continue compounding over that 10-year time period, and then take one full distribution of that total balance in the 10th year. If you wanted to, you could do it that way. Which I think is a strategy a lot of people do use who inherit Roth IRAs because as the balance in that account is compounding, all that growth is tax-free as well. So, you do want to leave it as long as you possibly can. But you could choose to take distributions anytime between year 0 and 10. And I think with with Roth IRAs, they can be so powerful and and as long as we educate our beneficiaries the the the best we can to help them understand what you just described, there’s a lot of power in compounding tax-free growth. And so, even sometimes in your tax strategy meetings, you know, we’re talking to people about doing conversions, and sometimes they’ll say, “I can, I can only, you know, the way the, the way the math worked out this year, I can only do 10 or 15 or 20,000 of a conversion because it’ll push me into IRMAA if I do more, or it’ll push me into another tax bracket if I do more.” And so, is there any reason to do that? Well, when you put it into this big picture perspective of let’s say you can only do 20,000, right? And maybe you can only do 20,000 of a conversion for the next 5 or 10 years. Let’s say it’s 10 years for easy math, right? Now, we’ve gotten about 200,000 into the Roth IRA that is growing tax-free, so maybe with some growth over 10 years, it’s actually worth about 150,000 at this point. And then you pass away. If we educate our our beneficiaries to the best of our abilities, and we tell them, “Hey, don’t touch this unless you have a massive emergency, and let this thing sit and grow for the entirety of the 10-year rule, and then you cash it out.” Just think about that. They inherited And where where it ends up kind of stopping is they think they’re they’re just going to inherit 250. Well, if we teach them right, they inherit 250, and they let it sit for another 10 years with decent money management and decent market returns, you know, that could easily grow to at least double. So, now you’ve got them cashing out a $500,000 account that really started at the beginnings with $20,000 contributions over time, right? So, I think when you put in that framing and you’re you’re debating on Roth conversions and doesn’t make sense for me and is it am I really going to move the needle on my inheritance? When you add in that 10-year rule layer, I think it can be pretty substantial and something to be thinking about, too, as you as you listeners are thinking about tax planning and the legacy you want to leave leave behind. any anything to add to Roth IRAs, Taylor? No, no, I think that’s perfect. it can be a motivation for doing Roth conversions during your own lifetime exactly for that reason, for what you leave your beneficiaries and if you want to be responsible for that tax liability on your traditional IRAs or if you want your beneficiaries to be responsible. And what makes sense as far as who pays the tax and when. So, and then I will also just remind that if you are on traditional IRAs and Roth IRAs, you should have those beneficiaries in place. Anytime we’ve got beneficiaries in place, regardless of what type of account it is, it gets away from probate, which is a thing that most people want to try to stay away from. There’s the complexity, the cost, and the public nature of being in probate and dealing with the court system. If we’ve got our beneficiaries in place, really all your beneficiary has to do is sign a couple documents, prove they are who they are, and then they get the in the inherited IRA or the inherited Roth IRA or the brokerage account pretty seamlessly. so, very important to have beneficiaries in place. All right, Taylor, let’s talk about real estate. This is one of the conversations that I have had with quite a few people around. You know, a lot of our clients have rental property, a lot of our clients have their their own homes, and and they wonder about what what the tax implications are going to be when they leave that behind. And sometimes they they say, “Well, is it better?” And actually, go ahead and talk about that, then I’ll ask you a separate question around titling around the properties. But, so how does real estate work when we leave it behind? So, real estate is similar to what we talked about with securities and brokerage accounts, real estate also gets a step-up in basis. So, again, let’s just say my mom buys a house for $100,000 30 years ago. She passes away and she leaves it to me as the beneficiary and now it’s worth $500,000. That $400,000 or whatever amount of appreciation in your situation is gone at the time of inheritance because it gets stepped up. So, if my mom had sold the house during her lifetime, she would have had to pay tax or would have been subject to tax on that appreciation. But, when I inherit it, because the basis gets stepped up, that’s my starting point for appreciation, like we said, really similar to any other sort of investment securities. So, I don’t have to worry about appreciation. If I sell the home right away, then I just get the $500,000 in cash proceeds or whatever that ends up being, then I do not pay any income tax on the value of that real estate transaction, whatsoever. If I keep the home and it continues appreciating and I sell it in a few years from now, that’s when any appreciation between the time I inherit it and the time I sell it could be subject to income tax. But, at least immediately upon inheritance, there is no need to worry about income tax on real estate. Right, And I know this this podcast in particular is all about inheritance, but I think when we’re talking about real estate, it’s always good for someone to understand on the primary home, the way that works on exclusions, capital gains exclusion. So, can you kind of talk us through an example of, you know, a husband and wife they own the house, they bought it for $500,000, today it’s worth a million and the talk about the exclusion? And let’s just say the husband passes away and; how does that operate for the surviving spouse? Yes, and unfortunately unfortunately we have had clients in that situation, which I hate to see, but yes, during your lifetime, when you own your primary home, where you live, there is a capital gain exclusion. If you’re a married, it’s $500,000. So, you can sell a home for $500,000 more than you originally bought it for and not pay any income tax. If you’re single, it’s half of that, so $250,000 capital gain exclusion that applies to your primary home when you sell it. If you own the home jointly with your spouse and then your spouse passes away, like in this example, you still have access to that $500,000 exclusion for 2 years following the death of your spouse. So, they give you a little window of time, 2-year time period, where you can still use that joint $500,000 exclusion and sell your home if that’s what you decide to do after the death of your spouse. So, I think if you know and we’ve seen it, unfortunately, like you said, a few handful of times where they were probably thinking about downsizing anyways and one of the the guidance is that we gave was, you know, “If you’re going to do it, do it within the next 2 years; otherwise, you’re going to end up paying some tax on the sale of it.” And so, a lot of times, you know, people don’t realize that unless they’ve got someone that understands how the tax code works. And that can save, you know, thousands of dollars in taxes for something that you were already going to do. It’s just more of the timing of it mattered way more in this type of scenario. All right. So, there’s a handful Oh, go ahead. Sorry, one other thing I was just going to add. At the time of death, too, it can be helpful to get an appraisal. Like if you inherit your parents’ home or whatever, to get an appraisal for the value of the home at the time that they pass away, just so you have that documented. Whether you choose to sell the property immediately or keep it for a period of time, it’s nice to just have that market value established when you do eventually sell the property to have that value to go back to as your starting basis. Or, you know, if you do report the sale and it’s non-taxable, then you just want to have some documentation. In the event you ever were to get audited by the IRS, you want to be able to justify the value that you use. So, that can be helpful to do. Anyway. I think that’s a really good point, too. Figuring out the value of property in the past is really hard to do. So, having that kind of moment in time is only going to help everyone’s scenario. All right. So, as we kind of wrap this up, Taylor, there’s a handful of other types of accounts that are out there. If you want to just kind of run through them and and your understanding of how the inheritance tax or lack of inheritance tax works on them. just the last couple like types of assets that are commonly part of an inheritance, life insurance. Generally, you don’t pay any income tax on that at all. So, that’s not too much of a concern. Non-qualified annuities can have tax implications when you inherit those. So, this would be an annuity, not an IRA. But, non-qualified annuities specifically, there is no step up that happens. So, whatever the original owner put into that annuity, and then whatever it grew to, that appreciation is going to be fully taxable to you as the beneficiary when you inherit that as well, just like it would be to the original owner during their lifetime. When you take distributions from a non-qualified annuity, you pay income tax on their earnings first. So, that transfers over to the beneficiary. There is no step up on non-qualified annuities. For HSAs, if you inherit an HSA from your spouse, you can continue to use that account as an HSA. But, for anyone else, if you inherit an HSA from your parent, like you’re the child inheriting it, or any other relationship aside from a spouse, you have to use the entire balance in the year that you inherit it. So, I think that one’s a little more rare. We don’t usually get questions about inheriting HSAs ’cause people use them during their lifetime. But, that’s important to know. Bonds, you just have to pay tax on the interest if you inherit those. And then any sort of like wages or like let’s say my mom is working and she passes away and she gets her final paycheck or something, you know, or her final Social Security distribution or benefit, whatever. Any income that they should have received during their life will be reported on their final tax return, but you as a beneficiary are not responsible for that tax that gets reported on the original recipient’s personal tax return for that year. So, I think that’s everything I had on my list. I I think I’m sure there’s there’s other things out there, but these are the most common that we come across. and so, if you’re listening to this and you’re you’re you know you’re dealing with something around inheritance, or you want to make sure that your plan is set up for the most seamless type of inheritance for your heirs, I mean, that’s a big part of what tax strategy and tax I’m sorry tax strategy and proactive tax planning is all about. a lot of you listening to us know that we put a big emphasis on tax planning. Taylor runs that entire department for us as our director of financial planning and tax strategy. And so we’re having constant conversations, annual meetings all around just taxes and how can we make be making our short-term as well as our long-term tax benefit as be-as good as it possibly can. So, if you’ve got questions around this episode or just questions in general and you want to hop on a call with us, we’re happy to do that. feel free to head to over to our website, pomwealth.net, and there are multiple avenues there where you can set up a phone call with us, and then we’ll have a conversation and say, “You know, here’s, here’s, here’s what we think and here’s how we think we could help,” or maybe “I think you’re all set,” and, and, you know, nice to, nice to talk to you. we’re not here to write it really try to sell anyone on anything that we do other than we we enjoy planning, we like solving the puzzles and that’s what we’re all about here at Peace of Mind Wealth Management. But Taylor, thank you again for your time today and your tax knowledge and expertise. We really appreciate it. I know our listeners do, too. of course.