I have $4 million in savings – will my kids get slapped with a huge tax bill when they inherit my money?

Dave Ramsey regularly shares financial insights that can help people move closer to their long-term goals. However, it’s not every day that a guest comes on the show and surprises Dave with a valuable tidbit.

That’s exactly what happened in this video. A Las Vegas caller with a $4 million portfolio talked about withdrawing funds from his traditional IRA and moving them all to his brokerage account. Right now, he has a $3 million IRA and $1 million in his brokerage account.

I’ll share some thoughts, but it is good to speak with a financial advisor if you can.

Who’s Responsible for the Tax Bill?

If you withdraw funds from your traditional IRA, you will end up with a tax bill. Your heir will have to pay taxes on any remaining traditional IRA funds. If you start withdrawing from a traditional IRA now, you minimize your heir’s tax burden. With a $3 million portfolio and only one daughter to give the inheritance to, it’s a good idea to trim it down.

However, your heir won’t have to deal with the tax bill right away. In fact, your heir has 10 years to withdraw all funds from the IRA. If the heir doesn’t touch it for the first nine years, they must withdraw everything in the 10th year, which would result in a massive tax bill.

What to Consider Before Using This IRA Withdrawal Strategy

It makes sense for the father to withdraw from his traditional IRA and put the funds into a brokerage account, especially since he’s close to retiring. However, it doesn’t make sense for everyone. 

If the father had three children, each of them would receive a $1 million inheritance IRA out of the $3 million. It’s still going to be an expensive tax bill, but people who can split their retirement accounts to multiple heirs will reduce the cumulative tax burden.

Furthermore, it makes more sense to withdraw from an IRA when your income is low. People who continue to earn high incomes in their 70s won’t benefit as much from rapid IRA withdrawals unless they have sufficient tax deductions available. It’s still good to whittle down the IRA instead of the brokerage account to minimize the tax burden on your heirs.

Another Key Advantage of the Brokerage Account

Although you get taxed on IRA withdrawals, it’s worth it to move some of those funds into your brokerage account. That’s because the assets in your taxable brokerage account qualify for a step-up basis. It’s one of the best tools for generational wealth.

Basically, if you bought a stock that is up by $100,000, that capital gain disappears when you give it to your heirs. Thisdoes not happen in a traditional IRA, so your heir is responsible for any capital gains accrued in your retirement account. A step-up basis is one of the best ways to shield your heirs from additional taxes, and moving funds from a traditional IRA to a brokerage account allows you to further capital on this advantage.