Let’s be honest—thinking about what happens to your assets when you’re gone isn’t exactly dinner party conversation. But if you’re like most people I work with in their 30s and 40s, you’ve probably accumulated a mix of bank accounts, investment portfolios, retirement savings, maybe some real estate, and if you have equity compensation, things get even more interesting. The reality? Not all assets are treated equally when it comes to inheritance, and understanding these differences can help save your family significant taxes and headaches.
Cash & Bank Accounts
- How it passes: Directly to named beneficiaries or through your will
- Tax treatment: No taxes on the principal amount*
- The catch: Interest earned in the year of death appears on decedent’s final tax return
- Pro tip: Joint accounts and named beneficiaries skip probate entirely
*Estate or inheritance taxes may apply depending on estate size and state laws. Please confer with your legal, tax and accounting advisors for more information.
Real Estate (Directly Owned)
- The benefit: Gets “step-up in basis” – cost basis increases to fair market value on date of death
- Example: House bought for $400K, worth $700K at death = heirs get $700K basis
- Why it’s great: Heirs can potentially sell immediately with little to no capital gains tax
- Bottom line: One of the best tax benefits for your heirs
Taxable Investment Accounts (Brokerage)
- Same step-up benefit: Cost basis for individual assets resets to date-of-death value
- The advantage: Decades of growth inherited with no income tax to heirs
- Example: Stock bought at $50, worth $200 at death = heirs get $200 basis
- Strategy insight: This is why advisors often recommend keeping highly appreciated assets until death
Pre-Tax Retirement Accounts (401(k), Traditional IRA) – “The Tax Bomb”
- The 10-year rule: Non-spouse beneficiaries must withdraw entire balance within 10 years
- Tax treatment: Every dollar withdrawn is taxable as ordinary income
- The problem: Can push heirs into higher tax brackets, creating a larger than expected income tax liability
- Why it’s problematic: No step-up in basis benefit
- Planning opportunity: Consider Roth conversions during your lifetime
Roth Retirement Accounts
- Same 10-year withdrawal timeline for non-spouse beneficiaries: But with a crucial difference
- Tax treatment: Distributions are typically tax-free to beneficiaries if the account is at least 5 years old
- Added bonus: Tax-free growth continues during the 10-year period
- The verdict: Often the most favorable assets to leave to heirs
Equity Compensation – “It’s Complicated”
- Vested equity: Gets step-up in basis like other taxable investments
- Unvested equity: Rules vary by company plan
- Some plans allow beneficiaries to receive accelerated vesting
- Others may forfeit unvested portions entirely
- Review your specific plan documents to understand plan provisions
- Stock options: Typically expire shortly after death unless plan terms specify otherwise
- Key takeaway: Estate planning is often very helpful for equity comp holders
Other Assets Worth Knowing
- Life insurance: Death benefits are generally income tax-free to beneficiaries
- Business interests: Often require special valuation and structured succession planning
The Bottom Line
Understanding how different assets are inherited can completely change your family’s tax situation. The step-up in basis for taxable accounts and real estate is incredibly powerful, while pre-tax retirement accounts can create significant tax burdens. If you haven’t reviewed your beneficiary designations lately or you’re not sure how your equity compensation would be handled, now’s the time to get that sorted. A little proactive planning today can help save your loved ones from incurring unnecessary income taxes and a lot of confusion during an already difficult time.
Any discussion of taxes is for general information purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.
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