Not all inherited assets are taxed the same way
Minimizing taxes for heirs often starts before assets are inherited, so careful planning can make a significant difference in the taxes they may eventually owe. How an asset is owned, what type of account it is held in, and whether it is transferred during life or at death can all affect the eventual tax consequences.
There is no single strategy for minimizing the taxes your children may face when they inherit. Depending on your circumstances, strategies may include being selective about which assets you gift during your lifetime, taking advantage of the step-up in basis available to certain inherited assets, considering Roth conversions, planning how retirement assets will pass to beneficiaries, and addressing potential estate or inheritance taxes before they become an issue. The right combination of strategies will depend on the assets you own, your tax situation, and the needs of your beneficiaries.
1. Understand which assets may create a tax burden for your children
- Cash and ordinary inherited property: Generally not treated as taxable income simply because it was inherited.
- Traditional IRAs and other tax-deferred retirement accounts: Children may owe ordinary income tax as they take distributions.
- Roth IRAs: Generally much more tax-friendly to beneficiaries, assuming applicable requirements have been met.
- Stocks, real estate and other appreciated property: These may receive a step-up in cost basis at death, potentially reducing capital-gains taxes.
- Life insurance: Death benefits are generally received income-tax-free by beneficiaries, although estate-tax considerations can sometimes come into play.
2. Be thoughtful about which assets you give away during your lifetime.
If you gift your children appreciated assets during your lifetime it can sometimes mean that they will receive your original cost basis. Yet, an appreciated asset inherited at death may qualify for a step-up in basis.
What does this mean?
When the original cost basis is transferred with a lifetime gift, the child’s tax basis for that asset is generally based on the original owner’s adjusted basis rather than the asset’s current fair market value (FMV). A step-up in basis means that the IRS resets the cost basis to the asset’s FMV on the date of the original owner’s death. This could result in a significant difference in the capital gains tax ultimately owed when the asset is sold.
For example: A parent bought a house for $200,000 in 1990. If the house’s fair market value is $900,000 on the date of the parent’s death and the child inherits it, the child’s basis would generally be $900,000. If the child sells the house at some point, they only pay the capital gains tax on the appreciation after they inherited. They do not pay taxes on the $700,000 gain from their parent’s lifetime.
If the child instead receives the parent’s original cost basis, a later sale could result in capital gains tax being calculated on a much larger gain.
Certain appreciated assets inherited from a decedent, including stocks, ETFs, mutual funds, real estate, bonds, business interests, and collectibles, may receive an adjustment in basis to their fair market value at death. Tax-deferred retirement accounts such as traditional IRAs and 401(k)s do not receive the same step-up in basis treatment as appreciated capital assets.
Gifting during your lifetime can still be part of your financial planning strategy depending upon your estate size and goals, but it can be helpful to speak with your financial advisor to discuss your specific circumstances.
3. Take advantage of gift tax exclusions during your lifetime.
Lifetime gifting can also provide opportunities to transfer assets to your children without triggering gift tax. In 2026, an individual can generally give up to $19,000 per recipient under the annual gift tax exclusion. For married couples, that can potentially allow up to $38,000 per recipient to be transferred annually, depending on how the gifts are made. Gifts above the annual exclusion may require a gift tax return and generally reduce the amount that can be transferred under the lifetime gift and estate tax exemption rather than automatically resulting in gift tax being owed.
Certain payments for education and medical expenses are treated separately. Tuition paid directly to a qualifying educational institution and qualifying medical expenses paid directly to the medical provider are generally excluded from gift tax and do not count against the annual gift tax exclusion or lifetime limits. These exclusions can provide another way to financially support your children or other family members while transferring wealth during your lifetime.
Because gifting appreciated assets can have different income and capital gains tax consequences than leaving those assets as an inheritance, lifetime gifting decisions should be considered as part of your broader financial and estate plan.
4. Consider whether Roth conversions belong in your estate plan.
Someone with significant traditional IRA assets might intentionally pay some tax during their own lifetime by converting portions to Roth. That could leave children with a more tax-efficient asset later. It’s important to note that Roth conversions are not right for everyone. The parent’s current tax bracket, expected future tax rates, Medicare considerations, cash available to pay the conversion tax, and the beneficiaries’ likely tax situations all should be considered before using this strategy.
5. Plan carefully for inherited retirement accounts.
IRAs are designed to grow tax-deferred. However, the IRS requires that funds are withdrawn over time so that they do not grow indefinitely in a permanent tax shelter. Once an IRA is inherited, the responsibility to take withdrawals shifts to the beneficiary, and if the original owner did not take their final RMD, the beneficiary may need to. Many non-spouse beneficiaries must empty an inherited retirement account by the end of the 10th year following the death of the IRA owner. The timing of required distributions during that 10-year period can vary depending on the circumstances, including whether the original owner had reached their required beginning date.
If you are passing retirement accounts to your children, planning when taxable distributions are taken may help avoid concentrating income into higher-tax years. It can be helpful to discuss withdrawal strategy with your financial advisor.
6. Do not overlook estate and inheritance taxes.
Federal estate tax generally affects larger estates, but state rules vary considerably. Depending on where someone lives and owns property, state estate or inheritance taxes may also need to be considered.
For families who may be affected by estate or inheritance taxes, advance planning can help identify potential tax liabilities and provide more time to consider strategies for transferring assets in a tax-efficient manner. Because federal and state tax laws and exemption amounts can change over time, it is important to review your estate plan periodically.
7. Review trusts and beneficiary designations as part of the overall strategy.
A trust does not automatically reduce the taxes your children may owe, but certain types of trusts can play an important role in a broader estate and tax-planning strategy. Trusts can also serve purposes beyond taxes, such as controlling how and when assets are distributed, protecting assets for beneficiaries, or providing for minor children or family members with special circumstances. The type of trust used, how it is structured, and which assets are placed in it can have very different tax consequences.
Beneficiary designations are another important part of the estate plan. Retirement accounts, life insurance policies, and certain other accounts pass according to the beneficiary designation on file. Reviewing these designations periodically can help ensure that they remain consistent with your overall estate plan and tax strategy.
8. Coordinate your financial, tax, and estate planning.
Decisions made in one area of your financial plan can create tax consequences in another. Gifting an appreciated asset during your lifetime, converting traditional IRA assets to a Roth IRA, changing beneficiaries, or establishing a trust should not be considered in isolation.
Your financial advisor can coordinate with your estate planning attorney and tax professional to evaluate different strategies and help you understand how decisions made today could affect both your finances and the assets your children eventually receive.
Planning today can help preserve more for your children.
The type of assets your children will inherit and the way those assets are transferred can have a significant impact on the taxes they may eventually owe. There is no single strategy that works for every family. Reviewing your assets, beneficiary designations, retirement accounts, and estate plan with your financial advisor can help identify opportunities to transfer your wealth in a more tax-efficient way. If you would like to learn more about how we can help you, please contact us.