Maximizing Wealth Transfer: Smart Strategies for Designating Beneficiaries

How to maximize your wealth transfer, smart strategies for estate planning and designating one’s beneficiaries.

When it comes to the intersection of personal finance and estate planning, maintaining and monitoring your beneficiary allocations is critical. If you’re a staunch listener of the Fed15 podcast, you’ve likely heard both myself and our founder, Dan Sipe, talk about how important it is to routinely review your beneficiary designations on all accounts at least once per year. But do you have a clear idea of your beneficiary strategy? Didn’t know there was any strategy to be found in listing beneficiaries? You’re not alone – but keep reading.

Most folks we come across in our work with federal employees and retirees have more or less the same approach to designating beneficiaries. Typically, those who are married with kids will list their spouse as 100% primary beneficiary and each of their children in an equal split as contingent beneficiaries, who will inherit the account in the event that the primary beneficiary pre-deceases the account owner. This is done in an attempt to simplify things, sure, but also out of a desire to make things fair or equitable amongst the children.

It’s an honorable goal; however, like many things in the realm of financial planning, it’s a bit more complex than it may initially seem. What if I told you that by splitting all of your accounts perfectly evenly between your children, you might be causing one or more of them to lose an inordinate amount of their inheritance to taxes?

Let’s visualize this with a (made-up) case study.

The Beneficiaries:

Mr. and Mrs. Client have three children: one works as a teacher, one works as a registered nurse, and one is an attorney. Obviously, their parents love all of them equally, and they want that to be reflected in their children’s inheritance. All three children, however, are in dramatically different tax brackets. Unfortunately, teachers’ salaries do not reflect their critical importance to our society, so the teacher is likely in the lowest tax bracket of the three, probably making $60,000 or so, which puts him in the 12% federal tax bracket, with an effective tax rate of about 10%. The registered nurse gets paid a bit more competitively, let’s say at around $100,000, which puts her just over into the 22% tax bracket, with an effective tax rate of 18%. The attorney gets paid the most of all the children— he’s making $450,000 per year and is solidly parked in the 32% tax bracket, with an effective tax rate of 28%.

It’s important to note here that the U.S. federal income tax is a progressive tax, meaning that just because your total taxable income puts you “in” a certain tax bracket, only the portion of your income that is in that bracket will be taxed at that rate. Your effective tax rate (AKA, the tax you actually pay) is an average of all the tax brackets that you’re exposed to. (Also, for the sake of our example, all three children are unmarried – more on how marriage impacts things later.)

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The Portfolio:

Mr. and Mrs. Client have worked hard, saved diligently, and invested prudently. Unfortunately, Mr. Client has pre-deceased his wife, and she is now the steward of the sizable portfolio they’ve built up. Understandably, Mrs. Client wants to ensure that their assets are distributed fairly amongst their children in the event of their deaths. Their portfolio consists of a Traditional IRA valued at

$1,200,000 (funded by a TSP rollover they did at the time they retired), a Roth IRA valued at $500,000, an HSA valued at $125,000, and a joint brokerage account valued at $800,000. They also own their home outright, and that is currently valued at $700,000. All told, they have an estate value of around $3,325,000 at present, excluding any jewelry, fine art, or family heirlooms they have to pass down.

Let’s examine what would happen if Mrs. Client took the route that most folks take and listed all three children as equal 33.33% beneficiaries on all of her assets. (It’s worth noting here that some custodians won’t allow you to list partial percentages in your beneficiary designation. In this case, Mrs. Client would have to list two children at 33% and one at 34%, but for the sake of our example, we’ll keep it exactly even.) The inheritance split would look like the following:

The teacher would inherit:

$400,000 of the Traditional IRA, which would be rolled into an Inherited IRA in his name
$166,666.67 of the Roth IRA balance, which would be rolled into an Inherited Roth IRA in his name
$41,666.67 of the HSA balance, which would be cashed out to him as a non-spouse beneficiary (definitely not ideal—more on that in my article on The Best and Worst Types of Accounts to Inherit)
$266,666.67 of the joint brokerage account, which would be rolled into an individual brokerage account in his name
Roughly a third of the value of the house, which would be $233,333.33.

Similarly, the registered nurse would inherit:

$400,000 of the Traditional IRA, again, rolled into an Inherited IRA in her name o
$166,666.67 of the Roth IRA balance, again, rolled into an Inherited Roth IRA in her name
$41,666.67 of the HSA balance, which would be cashed out to her as a non-spouse beneficiary o
$266,666.67 of the joint brokerage account, which would be rolled into an individual brokerage account in her name
Roughly a third of the value of the house, which would be $233,333.33.

And just for the sake of illustration, we’ll list out the attorney’s inheritance as well:

$400,000 of the Traditional IRA, again, rolled into an Inherited IRA in his name o
$166,666.67 of the Roth IRA balance, again, rolled into an Inherited Roth IRA in his name
$41,666.67 of the HSA balance, which would be cashed out to him as a non-spouse beneficiary o
$266,666.67 of the joint brokerage account, which would be rolled into an individual brokerage account in his name
Roughly a third of the value of the house, which would be $233,333.33.

Right about now, you’re probably thinking something like, “Looks pretty fair and equitable to me… maybe this financial advisor can’t do math.” Hang with me for just a bit longer, and let’s take a look at the tax consequences for each beneficiary’s situation:

The Teacher -- $60,000 annual salary – 10% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
Inherited IRA balance of $400,000	-10% tax of $40,000	Net inheritance of $360,000
Inherited Roth IRA balance of $166,666.67	no tax owed on Roth	Net inheritance of $166,666.67
HSA balance of $41,666.67, automatically cashed out and taxed as income	-10% tax of $4,166.67	Net inheritance of $37,500
Brokerage account balance of $266,666.67	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $266,666.67
1/3 value of real estate, equaling $233,333.33	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $233,333.33

The teacher has a total net after-tax inheritance of $1,064,166.67.

The Registered Nurse -- $100,000 annual salary – 18% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
Inherited IRA balance of $400,000	-18% tax of $72,000	Net inheritance of $328,000
Inherited Roth IRA balance of $166,666.67	no tax owed on Roth	Net inheritance of $166,666.67
HSA balance of $41,666.67, automatically cashed out and taxed as income	-18% tax of $7,500	Net inheritance of $34,166.67
Brokerage account balance of $266,666.67	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $266,666.67
1/3 value of real estate, equaling $233,333.33	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $233,333.33

The Registered Nurse has a total net after-tax inheritance of $1,028,833.34, which is a little over $35,000 less than the teacher.

The Attorney -- $450,000 annual salary – 28% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
Inherited IRA balance of $400,000	-28% tax of $112,000	Net inheritance of $288,000
Inherited Roth IRA balance of $166,666.67	no tax owed on Roth	Net inheritance of $166,666.67
HSA balance of $41,666.67, automatically cashed out and taxed as income	-28% tax of $11,666.67	Net inheritance of $30,000
Brokerage account balance of $266,666.67	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $266,666.67
1/3 value of real estate, equaling $233,333.33	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $233,333.33

The Attorney has a total net after-tax inheritance of just $984,666.67, which is about $80,000 less than the teacher and $45,000 less than the nurse.

As you can see from the detailed breakdown above, even though Mr. and Mrs. Client had the goal of splitting their assets evenly and fairly amongst their children, the net after-tax inheritances are drastically different. This is due to the tax bracket of the beneficiaries. If they had understood the tax implications of the various types of accounts in their portfolio and taken into account each of their children’s unique tax situation, they could have come closer to their ultimate goal of giving to each child equally by listing different beneficiaries on each account. It could look like this:

Traditional IRA – Teacher as 98% beneficiary, Registered Nurse as 2% beneficiary
HSA – Registered Nurse as 100% beneficiary
Joint Brokerage Account – Registered Nurse as 100% beneficiary
Roth IRA – Registered Nurse as 28% beneficiary; Attorney as 72% beneficiary
House – Attorney as 100% beneficiary

The above beneficiary designations would result in the follow net after-tax inheritances for each child:

The Teacher -- $60,000 annual salary – 10% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
98% of Traditional IRA balance, which is $1,176,000, rolled into an Inherited IRA	-10% tax of $117,600	Net inheritance of $1,058,400

The teacher has a total net after-tax inheritance of $1,058,400.

The Registered Nurse -- $100,000 annual salary – 18% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
2% of Traditional IRA balance, which is $24,000, rolled into an Inherited IRA	-28% tax of $112,000	Net inheritance of $288,000
100% of HSA balance of $125,000, automatically cashed out	no tax owed on Roth	Net inheritance of $166,666.67
100% of Brokerage account balance of $800,000	-28% tax of $11,666.67	Net inheritance of $30,000
28% of Roth IRA balance, which is $140,000, rolled into an Inherited Roth IRA	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $266,666.67

The Registered Nurse has a total net after-tax inheritance of $1,062,180.

The Attorney -- $450,000 annual salary – 28% effective tax rate:

Gross Inheritance	Tax Consequences	Net Inheritance
72% of Roth IRA balance, which is $360,000, rolled into an Inherited Roth IRA	no tax owed on Roth	Net inheritance of $360,000
100% of the real estate, valued at $700,000 –	step up in cost basis means no tax owed at time of inheritance	Net inheritance of $700,000

The Attorney has a total net after-tax inheritance of $1,060,000.

By structuring the beneficiaries appropriately, we’ve effectively reduced what was as high as an $80,000 spread between different beneficiary’s net after-tax inheritances down to a gap of roughly $3,780 between the highest and lowest net after-tax inheritances.

A couple of limitations to note about the above analysis: we are only examining the present-day after-tax value of the accounts in this analysis. In reality, beneficiaries would be permitted to stretch the income out from taxable accounts like the Traditional IRA over 10 years through RMDs. We’ve also not factored in what the increase in the beneficiaries’ income from the distributions would do to their effective tax rates (likely raise them significantly). Suffice it to say, though, that leaving 1/3 of a $1.2 million Traditional IRA to a beneficiary with a 10% effective tax rate and leaving that same amount of money in a Traditional IRA to a beneficiary with a 28% effective tax rate would result in drastically different net after-tax inheritance amounts.

So, what do we do with this information? Well, for one, we now understand that designating beneficiaries properly isn’t simply a matter of listing all your beneficiaries evenly on all your accounts. You have to take into consideration the account type, the tax implications, and your beneficiaries’ tax situations. But what if my beneficiary’s income changes over time? It’s likely that it will. That is why it’s important to review your beneficiary information at least once per year. Don’t just check that you have a beneficiary listed (although that’s a good start for some), talk to your kids about their income and their tax situation, and if things have changed, consider adjusting your percentages.

Implementing a more thoughtful, structured beneficiary designation like the one examined above can help you ensure that more of your money goes to the folks you care about, and less of it gets eaten up in taxes. If you do choose to go this route, be sure to talk with your beneficiaries about the strategy you’re implementing in order to promote understanding and prevent bitterness. It’s important that they understand the face amount of their inheritance might look very different than the net after-tax value. And since the net after-tax value is what they’ll actually get to keep and spend, that’s what matters most. Feel free to share this article and its example with them, if that aids in your discussion.

Remember, this is your money that you worked hard for. Make sure that your beneficiary designation allows as much as possible to go to the people you care about.

Katelyn Murray, CFP®, ChFEBC℠, FBS®, CFT-1™: Relationship Team Lead & Financial Planning Expert

Katelyn is a financial advisor with over a decade of experience working with Feds to build a healthy, balanced relationship with money and to design and enjoy the retirement of their dreams. In addition to her CERTIFIED FINANCIAL PLANNER™ and Chartered Federal Employee Benefits Consultant℠ designations, Katelyn also holds a Master in Business Administration as well as a graduate certificate in financial psychology and behavioral finance. Her unique approach merges financial psychology with traditional wealth management expertise to create an integrated financial planning approach that helps clients make the most of the one resource they can’t get more of: time.

Here at Serving Those Who Serve, Katelyn serves as our Director of Relationship Management, mentoring our advisors and guiding our client experience. She also co-hosts The Fed15 podcast each week with STWS founder Dan Sipe.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

**Written by Katelyn Murray, CFP®, ChFEBC®, FBS®, CFT-1™, ECA. The information has been obtained from sources considered reliable but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Katelyn Murray and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy suggested. Every investor’s situation is unique and you should consider your investment goals, risk tolerance, and time horizon before making any investment or financial decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. **