Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

Inherited pensions are taxed twice

- by Alan Duvall 

Published in Dayton Daily News July 9, 2006 

Congress is feverishly attempting to craft an estate tax repeal package before November elections.   

Proponents argue assets accumulated during lifetime have already been taxed and should not be double taxed merely because of owner’s death.  The logic of this particular point is best illustrated by the taxation of inherited (non-ROTH) pensions and individual retirement accounts (IRA’s). 

Assume four children each inherit $100,000 share of pension assets from their late parent ($400,000 total) and the estate and kids’ income are all subject to maximum marginal tax rates. 

Initially, parent’s estate must remit a 50% estate tax to Uncle Sam, or $200,000, on the value of retirement funds at death. 

Thereafter, income taxes are payable on the after-tax value of funds when distributed to kid beneficiaries.  In the example, the original $400,000 pension less $200,000 estate taxes are subject to an extra 40 per cent income tax of $80,000 upon distribution.  Some solace is achieved since the 10 per cent penalty tax for premature distributions will not be levied as well. 

In summary, each child will only retain $30,000 of the original $100,000 inherited pension – result of a confiscatory death tax of 70 per cent.   

Partial relief may be found from recent IRS rulings permitting related beneficiaries the option to roll over inherited pensions into IRA’s thus forestalling income recognition until IRA funds are later distributed to the owner.  The owner can make ratable distributions over the lifetime of the oldest (of the four in the above example) pension beneficiary.  

Unfortunately, a practical problem may be encountered with financial institutions not aware of these new rules.  Personal experience with institutional bureaucrats proves it difficult to teach an old dog new tricks.  Patience is truly golden in such frustrating moments. 

If maximizing the inheritable estate is the ultimate objective, the elderly may be well advised to spend down retirement assets in lieu of other assets for living expenses.  Alternatively, retirement assets are ripe for consideration of charitable contributions. 

This is a complex jungle requiring a knowledgeable guide for navigation.  Obviously, the journey would be markedly easier to chart if the estate tax were abolished.   

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.