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Video: How to Create Tax Efficient Beneficiary Designations

Video: How to Create Tax Efficient Beneficiary Designations

April 22, 2024



Hey guys, Mike Frontera here, back with another Retirement Theory video.

So how can you just by making a few simple tweaks to your beneficiary forms leave potentially tens

or even hundreds of thousands of dollars more to your beneficiaries in after tax dollars. So let's find out!

But first, if you like these videos, be sure to hit that like and subscribe button.

So the whole concept behind this is looking a little bit deeper into how assets are actually taxed when they're received through an inheritance. And despite starting with possibly equal beneficiary arrangements, different tax rates for different beneficiaries on different assets can lead to different net after tax inheritances.

So let's start right out with an example.

And we'll get to see how we can, by making a few simple adjustments, leave more to everybody. Well except maybe the IRS.

Okay, so we've got Jerry here. And let's assume that he's got two children, Jimmy and Janie. And he'd like to leave his children equal inheritances. He's also fond of animals, and he wants to leave some money to the ASPCA, which of course is a U.S. charitable organization under 501c(3). He has $600,000 in his IRA and $600,000 in a taxable investment account that he has invested a total of $100,000 into.

Now, he's decided that he'd like to leave each of his beneficiaries one-third of his estate. Gerry updates his beneficiaries on his IRA account to one-third to each beneficiary. He also creates a transfer on death registration on his investment account to also provide one-third to each beneficiary there.

Okay, now let's talk about Jimmy and Janie. So Jimmy is a vet tech at a local animal hospital, and he earns about $35,000 per year. He's married, and he has a modest household income of $60,000. Now, Janie is a cardiac surgeon, and she's single. She earns about $650,000 a year.

As you can see, Jimmy and Janie have very different incomes, and thus very different tax situations. For the purposes of this example, we're going to assume that Jimmy's marginal tax rate is 12% and Janie's is 37%.

For easy numbers, we're just going to assume that these tax rates and investment values stay as they are currently. With that, Jerry passes away and each beneficiary's after-tax inheritance is as follows:

You see, Jimmy, Janie and the ASPCA are left one-third of the IRA that was $600,000, which would give them a total of $200,000 each. On the taxable account, same exact thing. It's a $600,000 account, and each is left $200,000.


So Jimmy, at a 12% marginal tax rate, pays $24,000. And his after-tax inheritance is $376,000. Janie pays 37% tax on the $200,000 of IRA assets. And after paying $74,000 in taxes, is left with $326,000. Now, the ASPCA, as a charitable organization doesn't pay any tax on any of the inheritance money that they receive.

So, you're going to see that Jimmy pays less in taxes than Janie. And of course, the ASPCA pays nothing in taxes. Also note that the taxable account that is received despite only having put $100,000 into it and it being worth $600,000, that death taxable accounts under current law receive a step-up in cost basis and so that money is received by any of the beneficiaries without any income tax.

Ok, so in the end, Jimmy receives 376,000 after tax, Janie $326,000 and the ASPCA $400,000.Oh, and 98,000 goes to the IRS, despite Jerry's desire to benefit everyone equally. Obviously that is not the result.

However, by changing which beneficiary receives which asset, he can effectively leave more to the people he cares more about and only effectively reduce the share that is given to the IRS. So let's start with what's given to the ASPCA. Well, since they can receive IRA assets without paying any income tax, Jimmy decides to leave the $400,000 that was going to them all in IRA assets.

Then, with the remaining $200,000 of IRA assets he leaves those to Jimmy, who is going to pay the least amount of tax. So you can see here Jimmy receives $200,000 in the IRA, which he's going to pay 12% tax on, which is $24,000. And then to make things equitable for Janie, he is going to skew that beneficiary arrangement, 65% to Janie and 35% to Jimmy. So Jimmy is going to receive $212,000 in the taxable account. And so his net after-tax inheritance is $388,000. Janie has none of the money from the IRA coming to her, where there would be the biggest tax drag and instead receives all of her inheritance through the taxable account. So she also receives $388,000.

So both Jimmy and Janie have received more in after tax money than they had under the previous beneficiary arrangement. Jimmy's is higher by $12,000 and Jane's by $62,000, so it seems like it's really a win for everybody.

However, there are a few important things to keep in mind. First, is that the beneficiary calculations have to be made very carefully. Also, they have to be managed more actively. You know, Jimmy and Janie says income tax rates may change over time. And of course, the value of the taxable account in the IRA account are going to change over time. So this may require a more active monitoring of all of those factors and more frequent beneficiary updates.

Now Jerry can also adjust the language in his will to have his executor use some of the probate assets to help equalize those after-tax totals for his beneficiaries. He would, of course, discuss this with his estate attorney to help make that happen. But in general, of course, IRA or for 401(k) assets are excellent assets to leave to charitable organization because they don't pay taxes on any of that money that they receive. So if you're charitably inclined, this is certainly an important factor. In this strategy, is certainly the most effective when you have beneficiaries that have large differences in their tax rates. And when you have multiple different types of assets that you plan to leave. This was certainly the case for Jerry when he had equal parts of IRA assets that were fully taxable and taxable assets that received a step-up in basis and came in tax free.


So do you have questions for me? Let me know. Come visit me at or send me an email at Thank you so much for watching. We'll see you next time.