Leaving Qualified Plans to Beneficiaries (and Cake)


by Tyson Ferney, Advanced Markets Director @ Allegis Advisor Group

My wife mentioned that she never gets a cake when her birthday rolls around.  I searched her favorite Pinterest sites for that one cake or recipe which would totally redeem myself. This year I had good intentions to change pattern, but luckily for me my Chef Boyardee skills were put on hold.  Truth be told she was probably the one who lucked out. For those with an eye for the bizarre, several internet sites feature cake disasters with pictures of not-so-perfect culinary creations. Google “cake fails” to see photos of truly disastrous cakes, or watch an episode of “Nailed It” on Netflix with your kids for a good laugh.  All these cakes start with good intentions and for the most part tasty ingredients, but somewhere along the way the plan got foiled and the final person to eat the cake may do so reluctantly.

 In much the same way, income taxes owed remain income taxes owed, even after the person who owes them has passed away. Income paid to an individual’s estate (e.g., a final paycheck, deferred compensation, uncollected rent, etc.) is called “income in respect of a decedent” (IRD)—income the decedent earned or had a right to prior to death, but which was not included in the decedent’s gross income prior to death. Just as the disaster cake is still a cake, income in respect of a decedent is still considered taxable in the same way it would have been had the individual still been alive. While IRD is includible in the estate of the decedent, it retains the same character it would have had in the hands of the decedent. If the IRD is ordinary or capital gain, for instance, the estate may use the decedent’s basis to offset the gain but may not step up the basis to the fair market value. So, what happens if a client fails to provide enough estate liquidity to cover these taxes that will come due immediately after death? An estate that is forced to sell assets to pay taxes can almost certainly count on not obtaining the highest possible price for those assets—not to mention the fact that these assets will no longer be available for other purposes, such as providing an inheritance or making a charitable gift.

How to Avoid Disaster: A lack of estate liquidity should never be a surprise disaster—many estates will have IRD, and preparation is key to covering the taxes that result. It can be beneficial to explain IRD and its tax impact to clients while helping them plan for estate liquidity. Assist clients with asset and income recognition, estimate the necessary funding to cover the resulting tax, and encourage clients to use life insurance to secure estate liquidity.  You may have noticed recent legislation proposing an end to the “stretch IRA” designs. Most don’t anticipate tax rates to go lower in the future.  Nor do they think about the tax consequences for their children if they inherit a taxable qualified plan. Consider recognizing that beneficial tax now in a lower rate environment. If it makes sense, you can distribute more than the minimum distribution to purchase a life policy that can provide the liquidity for the tax when the client passes away.  This life policy could also have living benefits which could provide another unique opportunity.


For questions or more information please reach out to Tyson by email or at (801) 826-2600

Layne Turner