The Relationship Between Taxes and Retirement Accounts in Estate Planning

1 July 2025

When it comes to estate planning, most people think about wills, trusts, and maybe power of attorney—but what often gets overlooked is the major role taxes play, especially when it comes to retirement accounts. If you've spent decades socking money away into accounts like 401(k)s, IRAs, or Roth IRAs, it’s crucial to understand how Uncle Sam fits into the picture when you pass those accounts on to your heirs.

In this post, we're diving deep into how taxes and retirement accounts intersect in estate planning. The goal? Help you avoid costly mistakes and keep more of your hard-earned money in the hands of the people you love.

Why Retirement Accounts Matter in Estate Planning

So you've built a solid retirement nest egg—congrats! But here’s the thing: Not all retirement accounts are created equal when it comes to taxes. Depending on the type, your beneficiaries could face a surprising tax bill after you're gone.

Retirement accounts often make up a big chunk of a person’s estate. This makes understanding their tax treatment not just smart—it's essential for anyone who wants to leave a legacy and not a liability.

The Tax Basics of Retirement Accounts

Before we get into the nitty-gritty of estate planning, let’s unpack the tax rules for typical retirement accounts:

1. Traditional IRA & 401(k)

Think of traditional IRAs and 401(k)s like a long-term “tax postponement” deal. You contribute pre-tax dollars, the money grows tax-deferred, and taxes come due when the funds are withdrawn. Sounds good in theory… until your heirs inherit the account.

Here’s the catch: Your beneficiaries will have to pay ordinary income tax on the full amount when they take distributions. Depending on how much they inherit, this could push them into a higher tax bracket.

2. Roth IRA

Roth IRAs are the golden children of estate planning. Since contributions are made with after-tax dollars, qualified withdrawals (including by your heirs) are tax-free. This makes Roth IRAs a powerful tool for passing on wealth without triggering a tax time bomb.

3. SEP IRAs, SIMPLE IRAs, and Other Plans

These accounts follow tax rules similar to traditional IRAs. The IRS will eventually take its cut—either from you or your beneficiaries. So don’t assume these are “set and forget” assets when it comes to your estate.

Estate Taxes vs. Income Taxes: What's the Difference?

This is where things get confusing. Lots of people mix up estate taxes and income taxes, but they’re totally different animals.

- Estate Taxes: These are taxes on the total value of your estate at the time of your death. As of 2024, the federal estate tax kicks in for estates larger than $13.61 million. Some states have their own thresholds too.

- Income Taxes: These apply when your heirs actually take money out of the inherited retirement account. And trust us, the IRS is watching.

So yes, it’s possible for your heirs to face both estate and income taxes on the same assets. Let that sink in for a second.

The SECURE Act Changed Everything

In 2020, Congress passed the SECURE Act, and it flipped the script on how inherited retirement accounts are treated.

The 10-Year Rule

Before the SECURE Act, non-spousal beneficiaries could “stretch” the distributions over their lifetimes, minimizing annual tax hits. Now? Most heirs have to drain inherited IRAs and 401(k)s within 10 years of the original owner’s death.

That’s right—even if your kids are in their peak earning years, they’ll have to pull out the money (and pay taxes on it) in a decade or less. Which could mean coughing up a lot of taxes fast.

Who Gets a Break?

Not all beneficiaries are treated equally. The “Eligible Designated Beneficiaries” who are exempt from the 10-year rule include:

- Surviving spouses
- Minor children (only until they reach adulthood)
- Disabled or chronically ill individuals
- Beneficiaries not more than 10 years younger than the account holder

If you’re naming your kids or grandkids as successors, most won’t qualify for this exception.

Naming Beneficiaries: More Than Just a Formality

You might think naming a beneficiary is just ticking a box, but it’s actually a big tax decision. Here’s why:

- If you name your spouse as the beneficiary, they can roll the funds into their own IRA and delay required minimum distributions (RMDs). It’s a sweet deal.

- If you name your kids, they’re subject to the 10-year rule—and potentially much higher taxes.

And don’t make the mistake of naming your estate as the beneficiary. This could force the account into probate and lead to even worse tax treatment.

Need a pro tip? Always review these beneficiary designations regularly—especially after major life events like marriage, divorce, or the birth of a child.

Roth Conversions: A Smart Tax Move?

Let’s say you’ve got a big traditional IRA and you’re worried about your heirs getting slammed with taxes. You might consider converting it to a Roth IRA while you’re still alive.

Sure, you’ll pay taxes on the conversion now, but your heirs get to inherit a tax-free account. It could be a strategic move—especially if you’re in a lower tax bracket now than your kids will be in later.

But run the numbers carefully or work with a financial advisor. Roth conversions can be powerful, but they're not a one-size-fits-all solution.

Trusts and Retirement Accounts: Handle With Care

People love trusts for estate planning, and they can be incredibly useful. But when it comes to retirement accounts, adding a trust into the mix can get… well, messy.

Here's the issue: If the trust isn’t properly set up, it could force the retirement account to be paid out all at once—which could trigger a massive tax bill. Used correctly, though, trusts can provide creditor protection, control cash flow, and ensure funds are used responsibly.

If you're considering naming a trust as the beneficiary of your IRA or 401(k), work with an estate lawyer who knows the ins and outs of retirement account rules.

Charitable Giving and Retirement Accounts

Want to leave some money to charity? Retirement accounts make that easy—and tax-smart.

Why? Because charities don’t pay income taxes. So if you leave part (or all) of a traditional IRA to a qualified charity, it doesn’t trigger any tax at all. Your heirs avoid income taxes, and the charity gets the full amount.

You can even use a Qualified Charitable Distribution (QCD) during your lifetime to give money directly from your IRA and reduce your RMDs. It’s a win-win.

How to Maximize Retirement Accounts in Your Estate Plan

Here’s a quick game plan to help you make the most of your retirement accounts:

1. Diversify Between Traditional and Roth

Having both types gives you (and your heirs) flexibility in managing taxes.

2. Consider Roth Conversions

Especially during lower-income years, gradually converting funds can save a ton in future taxes.

3. Review and Update Beneficiaries

It’s easy to forget, but this one simple step can make a huge difference.

4. Educate Your Heirs

Let them know how these accounts work. A heads-up today can save them from an expensive surprise later.

5. Work With Pros

A good financial planner and estate attorney can help you spot opportunities and pitfalls. Don’t DIY something this important.

Final Thoughts

Taxes and retirement accounts are like that weird couple you can't quite figure out—they’re separate but deeply connected. And when it comes to estate planning, ignoring one means risking big trouble down the road.

The key is being proactive. Take the time to understand how your retirement accounts fit into your estate plan, and make a few smart moves now while you still can. Your future heirs will thank you (and so will your accountant).