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When is an equal distribution of assets a bad idea?

It is common for those who put together an estate plan to attempt to distribute assets to heirs in equal portions. The idea behind the move is logical — each kid gets an equal share of the parent’s or grandparent’s assets. But does it end up working this way?

The next series of posts will delve into this question. This, the first post, will discuss an example of an unequal transfer. The next post will provide some resolutions to increase the likelihood that an estate plan will result in an equal transfer of assets.

Unequal transfer: Retirement assets

The transfer of a tax-deferred IRA will result in tax obligations. A recent publication in Kiplinger notes that after transfer, an IRA or other tax-deferred retirement account often only result in the beneficiary receiving 65 percent of the value listed in the account. The rest goes to pay off federal and state tax obligations.

In contrast, taxable investment accounts transfer at a “stepped-up” rate. This means the asset’s cost basis is increased the fair market value at the time of the transfer, resulting in a tax advantage for the recipient.

Now apply this information to a scenario. Bob and Judy have $1 million in an IRA and $1 million in a taxable money market mutual fund. They decide to set up an estate plan that transfers the IRA to their son, Jake and the money market fund to their daughter, Jane. Is the split even? Although Jake and Jane’s tax obligations will impact the exact details of the transfer, it is unlikely the transfer will be fair. Jake will likely have to pay a larger portion of taxes on his inheritance while Jane will not. Ultimately, in this example Jane will likely get a larger inheritance in the scenario.

Bob and Judy can take proactive steps to better ensure an equal transfer. These steps will be discussed in a future post.

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