The Hidden Power of “Income in Respect of a Decedent” (IRD)

Our friends at DP Legal Solutions discuss how when planning your estate, most people focus on the “stepped-up basis” rule, which allows heirs to inherit assets like real estate or stocks without paying capital gains tax on the previous growth. However, many clients are surprised to learn that retirement accounts do not follow this rule. A trust administration lawyer can help you understand these distinctions and develop strategies to manage the tax burden of Income in Respect of a Decedent. Contact an experienced lawyer today to learn how to manage the tax burden of “Income in Respect of a Decedent” (IRD).

What Exactly is IRD?

Income in Respect of a Decedent (IRD) refers to income that the deceased person was entitled to receive but had not yet collected before their death. For most people, the largest source of IRD is their traditional IRA or 401(k). Because these accounts were funded with pre-tax dollars, the IRS still wants its cut of the income tax when those funds are eventually distributed.

Unlike a house, which gets a “stepped-up” value to the current market price upon death, retirement assets retain their “zero basis” status. This means every dollar your children or spouse withdraw from a traditional inherited IRA is generally treated as taxable ordinary income.

The IRD Planning Challenge

The challenge with IRD is that it can create a massive tax bill at the exact moment your heirs are trying to manage your estate. If you leave a $1 million IRA to a child who is already in a high tax bracket, and they are forced to liquidate that account over ten years due to the SECURE Act, a significant portion of that legacy could vanish into taxes.

Strategies to Mitigate the IRD Hit

We look for ways to offset the impact of IRD:

• Charitable Giving: If you are charitably inclined, naming a 501(c)(3) organization as the beneficiary of your IRA is often the smartest move. Since charities are tax-exempt, they receive 100% of the funds, whereas a human heir might only receive 60% after taxes.
• Roth Conversions: Converting a traditional IRA to a Roth IRA during your lifetime allows you to pay the tax now so your heirs can receive tax-free distributions later.
• Life Insurance: Some clients use life insurance to provide heirs with a tax-free “pot of money” specifically intended to pay the income taxes due on the inherited IRA.

Understanding how IRD works is the key to ensuring your family keeps the wealth you worked so hard to build. To create a tax-efficient distribution plan, contact an experienced lawyer today.