Some assets are fantastic to hold onto in estate planning but others can be bad for you and your heirs. One of the key objectives when planning your estate is to keep the tax bill as low as possible for your heirs when they are bequeathed portions of your estate. The following is a ranking of the good, the bad, and the ugly of retirement assets that you should leave for your heirs.
Depleted partnerships: The best asset to keep in an estate plan is also a bit of a head-scratcher. While the taxation of partnerships is complex and at time counterintuitive, there are two important things to keep in mind.
First, the IRS takes a harsh view of selling partnership stocks, even if they have depreciated over time. Often, a sold partnership will get hit for capital gains tax as well as be taxed on what the IRS considers “recapture of depreciation.” Second, if you pass a depleted partnership onto your heirs they receive it at the stepped-up value and do not have to pay for the capital gains or recaptured value up to that point.
Collectibles: This category includes assets like artwork, gold, coins, and similar valuable collectibles. These assets are taxed at a 28% rate if sold during the lifetime of the buyer, so it is smarter to hold on to collectibles and sell lower taxed items like stocks and bonds.
Highly appreciated stock: The same concepts in a depleted partnership apply to highly appreciated stocks. Let your heirs receive the stepped-up basis and waive the capital gains tax.
Roth IRAs: Once you have paid the income tax on a Roth IRA the income is tax free for your heirs. The money compounds in the Roth IRA tax free, and the withdrawals are tax free.
Somewhat appreciated stock: While these assets can have some benefits, typically the value is not as much as a tax-free Roth IRA or higher appreciated stock.
Taxable IRAs: These include all retirement funds that contain untaxed contributions. If you cash in a taxable IRA before death then you pay income tax on the withdrawals, and if the heirs receive it then they pay taxes, too.
Bonds: Similar to somewhat appreciated stock, the return on bonds for your heirs will not be nearly as great as other assets in this list. If a bond has appreciated in value over time it has only been by a little. These are safe assets to liquidate and invest in better options.
Cash: Simply bequeathing cash to your heirs gives them no added benefit compared to the other assets in this list. Not only will the cash be taxed, there are no other tax incentives that come with receiving cash in an estate.
Depreciated securities: If you pass away with a depreciated asset the entire capital loss deduction is erased. This is the mirror image of the stepped-up rule; this is the stepped-down rule. You can use capital loss deductions to offset capital gains plus up to $3,000 per year of ordinary income. In addition, unabsorbed losses are carried forward into future years. All of these benefits are lost if you wait and attempt to pass these assets on in your estate.