Your Heirs Will Pay the Taxes on Your Qualified Plans

Death vs taxesOur investment strategy needs to change during retirement. Nor should our investment strategy ever be set to autopilot unless we are willing to see our financial legacy further diminished by unnecessary taxes! 

As you purchase an annuity or contribute to your IRA accounts during your working years, rules and regulations mandate that you treat these accounts as ‘retirement savings’.  Nothing wrong with that but the problem is that many continue to save these accounts after their retirement continuing to think of these accounts as the last resort when paying bills.  The problem with that is that you may be saving these accounts for your children while simultaneously handing the IRS more money from these accounts than you intended; in retirement your income declines and therefore so too your income taxes especially if you are entitled to a medical deduction whereas your children are likely at their highest earning potential when they inherit these accounts.    

Unlikely Virginia, there are states where there’s an inheritance tax.  In that case, who pays the inheritance tax on top of the income taxes that will be due?. The inheritance tax will be based on the value of the annuity or some IRAs and the inheritor relationship to the deceased.

For example, in New Jersey, transfers for less than $500, life insurance proceeds, and certain state and federal pension payments are exempt.  However, everything else is subject to the inheritance tax. This includes items controlled by beneficiary designations, instead of a will, like an IRA, 401(k) or annuity. If it’s an annuity at issue, the date of death valuation must be listed on the New Jersey Inheritance Tax form (IT-R), which is for assets left to Class D beneficiaries. The personal representative (or executor or administrator) of the estate has a fiduciary duty to file the inheritance tax return (Form IT-R). The tax return, along with payment for any taxes owed, is due eight months from the date of death in that state.

The person responsible for paying the tax depends on the deceased's will. For example, the will could state that all estate or inheritance taxes are paid out of the deceased's residuary estate, which is the part of a deceased's estate that remains after all debts have been paid and specific bequests have been distributed.

If the estate has sufficient funds to pay the tax, the beneficiaries won't owe anything.  However, the will could state that all estate/inheritance taxes are paid proportionately by the recipient, even for assets not controlled by the will. That’s the default in New Jersey when the will doesn’t say how death taxes get apportioned or the deceased died intestate (without a will).

There can be an issue when the beneficiary refuses to pay his or her share. In that case, the executor is still obligated to pay the tax with other estate funds, if any, which will negatively affect the inheritance of other beneficiaries under the will.

In that case, the executor can sue to recover the funds from the non-paying beneficiary. If the executor can't pay the tax because there aren’t enough funds in the estate, the state of New Jersey will bring a delinquency claim directly against the non-paying beneficiary.

To avoid either one of these scenarios, you should pay your share of the tax (if any) as requested by the executor.

Reference: nj.com (May 14, 2018) “Who pays inheritance tax on an annuity?”


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