Does Everything Have to Go to the Kids?

Most estate plans start from the same unspoken assumption: whatever is left when you die goes to your children, split evenly. For many families that’s exactly the right answer. But it’s worth pausing on that assumption before locking it into a plan, because the tax code treats different assets very differently depending on who inherits them — and the gap can be large enough to change how the whole plan should be built.

Consider someone weighing their options, without children of their own, who’s decided to leave assets to a mix of extended family and causes they care about. A meaningful part of the estate sits in a traditional IRA. It’s tempting to think of an inheritance as an inheritance — that cash is cash, regardless of the account it comes from. It isn’t. When a family member inherits a retirement account like an IRA or 401(k), current law generally requires the full balance to be withdrawn within ten years, and every dollar withdrawn is taxed as ordinary income. Depending on the heir’s tax bracket in those years, a significant portion of a $200,000 IRA may be subject to federal and state taxes before it’s ever spent. Consult your tax advisor for personalized guidance.

Compare that to what happens when a qualified charity inherits the same account. Generally, a 501(c)(3) organization may not owe income tax on the distribution under current federal laws. Consult your tax advisor for personalized guidance. Meanwhile, other assets — a home, a brokerage account — typically receive a step-up in cost basis when they pass to heirs, meaning most of the embedded capital gains disappear for tax purposes. Family members inheriting those assets can sell them with little or no capital gains tax due.

Line those two facts up and a strategy suggests itself. Rather than splitting everything evenly, some individuals may consider directing retirement accounts — which are often taxed heavily when passed to individuals — toward charity, where they may pass untaxed under current federal laws, while leaving stepped-up assets to family. Consult your tax advisor for personalized guidance. Done well, family members may retain similar spending power compared to an even split, while potentially reducing the IRS’s share. However, such strategies can involve complexities and should be carefully planned with professional advice.

The charitable portion of a plan like this doesn’t have to be one lump gift to one organization. Someone in this position might choose to fund a scholarship at a local community college, structured to spend down over ten years rather than sit as a permanent endowment — a defined, visible impact rather than a fund that exists indefinitely and gradually becomes more about institutional upkeep than about people. The remainder might go to causes closer to home: a food pantry, an animal shelter, whatever reflects where the person’s actual time and attention have gone over the years.

The family gifts themselves are also worth structuring deliberately. Rather than leaving open-ended amounts that heirs can do anything with, it’s possible to assign specific purposes and specific dollar figures to each gift — enough to matter, not so much that it creates its own set of problems. What “enough” means is a judgment call every person has to make for themselves, but it’s worth making on purpose rather than by default.

None of this stems from a belief that family shouldn’t inherit. In this scenario, family is still very much part of the plan. It stems from a willingness to ask a slightly uncomfortable question: if the goal is to help the people and causes you love, is an even split actually the most effective way to do that, or just the most familiar one? Sometimes the honest answer is that a more deliberate structure — one that accounts for how each asset is actually taxed, and how much any one person truly needs — serves everyone better than a plan built on habit.

If you’re working through your own estate plan, this is worth raising with your advisor before you decide who gets what. Which assets go to whom can matter as much as how much you leave in total.

This article was written by Matthew Fitzgerald, CFP® founder of Holistic Planning – Sedona. For more information about our services, visit holisticplanning.com/sedona.

This content is intended for general educational purposes and does not constitute tax, legal, or investment advice. Tax laws are subject to change, and their application depends on individual circumstances. Please consult your tax, legal, or financial professional before implementing any strategy.
Before making any financial decisions, readers are encouraged to consult with a qualified financial professional. The views expressed may not reflect those of Uptick Partners, LLC as a whole. Uptick Partners, LLC does not guarantee the accuracy or completeness of any information contained herein and is not responsible for any errors or omissions.