6 Tips for Passing Tax-Free Money to Your Heirs

Key Takeaways

  • Inherited assets often come with tax burdens
  • Planning ahead simplifies some of the inheritance process
  • Following some helpful tips can limit the taxes your heirs owe
  • Speaking with an advisor delivers additional tax minimization strategies

Developing a plan for your money becomes a priority as you age, especially if you have heirs. These family members might rely on you financially, so you’ll want to ensure they’re taken care of when you’re gone. 

You’ve already paid tax on your hard-earned assets, and figuring out how to avoid taxation on inheritance money ensures your heirs aren’t on the hook for additional tax burdens. This guide will provide tips on how to pass money to heirs tax-free when you pass away.

What Are Taxes on Inheritance?

The government can tax inheritances in various ways, depending on the state in which the deceased had their estate and the assets the beneficiary is inheriting. The first type is estate tax, which comes directly from the estate before any assets change hands. Only 16 states plus the District of Columbia have estate taxes, but there is a federal estate tax on estates worth more than $12.06 million.

Inheritance tax is only present in six states and forces the beneficiary to pay taxes on inherited assets. The tax applies to the state where the beneficiary lives rather than the deceased’s home state. Inheritance tax rates range from 0–18%, depending on the state.

State and federal income tax could apply to an inheritance as well. The beneficiary shouldn’t need to pay tax on most assets, but capital gains on inherited retirement accounts, real estate, and stocks could be added to their taxable income.

Estate Planning Tips

Developing a plan before you pass away can help you reduce estate tax. It also makes the entire distribution process easier on your heirs. Ways to plan your estate include: 

-Write a Will 

Creating a will is a basic estate planning strategy stipulating how your heirs will divide your assets when you die. This document prevents probate court from dividing your assets and having an outside entity decide who gets what. Anyone serious about providing for their heirs once they’re gone must write a will.

-Name Beneficiaries 

You’ll want to name beneficiaries for all of your assets. Putting names on everything simplifies the process and ensures the right people receive the assets you want them to receive. Having a precise plan in place makes it easier to reduce taxes as your successors receive your money.

-Create a Trust 

Putting your assets into a trust means they no longer belong to you and, therefore, aren’t subject to estate tax. You can appoint yourself as trustee of this fund while you’re alive, ensuring you can access your assets and distribute the money as you see fit. You can then will the trust to an heir when you pass away.

Creating a long-term inheritance plan for your loved ones can make their lives easier when the time comes. Speaking with an advisor streamlines the process, as there are numerous factors you’ll need to consider as you develop this plan.

6 Ways to Minimize Your Heirs’ Tax Burden

There is still the question of how much your heirs can inherit without paying taxes, and the reality is that it depends. There are some steps you can take to minimize taxes, though, giving your heirs an advantage:

1. Gift Your Money

Start by gifting your heirs money every year. The IRS includes an annual gift exclusion of $16,000 in 2022, allowing individuals to give that money to anyone they wish without tax repercussions. Those wishing to keep their heirs from having to pay inheritance tax should consider simply gifting them cash annually.

2. Convert Retirement Accounts to Roth Accounts 

Your heirs will have to pay tax on any retirement benefits they inherit if they’re in a 401(k) or IRA. The tax is already settled on a Roth 401(k) or Roth IRA, though, so when you convert there’s no additional tax when taking distributions. You will, however, have to pay regular income tax on the converted amount to make the switch.

3. Life Insurance

A good life insurance plan can set your heirs up in the future. You’ll want to choose between term life insurance and whole life insurance, as your selection determines how long the policy lasts. Whole life insurance is your best bet if you don’t anticipate you will pass on during another policy’s term.

4. Annuities with a Death Benefit

Annuities with a death benefit provide a lump sum payout for your beneficiary. You can also opt for a joint-and-survivor annuity that provides your beneficiary with a guaranteed income stream for life. Annuities are subject to income tax, but you can structure them in a way that minimizes the beneficiary’s tax burden.

5. Real Estate

Real estate will likely be one of the most significant non-liquid assets you pass to your heirs. Capital gains tax applies to real estate, but only on gains the property makes after the beneficiary inherits it. Heirs that sell a property as soon as they inherit it won’t pay any capital gains taxes, making real estate an excellent way to pass tax-free money to your loved ones.

6. Investment Accounts

Your investment accounts can provide tax breaks for your heirs. Investments are similar to real estate because your beneficiaries are only on the hook for taxes on the gains those investments make after they inherit them. Selling stocks and other investments immediately provides beneficiaries with potentially significant tax-free earnings.

Learning how to pass money tax-free is complicated because there are so many laws and tax types in play. Taking the time to understand how tax savings work can assist your heirs in the future.

How to Reduce Your Heirs’ Taxes

You want your successors to have everything they need when you’re gone, so limiting the tax they’ll pay on their inherited assets is essential. The best way to develop a streamlined plan is to speak with an estate planning advisor to help you create a multi-generational strategy for your family.

Bogart Wealth specializes in preserving, growing, and transferring our clients’ wealth. We have the experience you need in multi-generational estate planning to create the ideal solution for your heirs. Contact Bogart Wealth today to speak with an expert about your tax concerns.


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