When To Say “No Thanks” To Free Money
When I was growing up, my Nana – who went through the Great Depression – always reminded to take monetary gifts whenever they were offered.
But there may be a few exceptions to her advice.
For example, maybe a beneficiary doesn’t want to be taxed on the inheritance…
From the taxman’s point of view, disclaiming property is like never owing it.
Here’s one scenario where that would be an advantage.
You disclaim your rights to a retirement account coming your way in favor of your child because they’re in a lower tax bracket. Those funds would also be removed from your taxable estate.
And for qualified retirement accounts, such as IRAs, the tax benefits are greater yet…
As I explained in a separate Roadmap, whoever inherits an IRA must remove the funds per the IRS’ life expectancy tables in Publication 590. And income taxes are due on each withdrawal.
The longer the life expectancy, the smaller the annual Required Minimum Distributions (RMDs)
So, for instance, if you are 55 years old and inherit an IRA from your brother who dies this year, your first distribution must be taken by the end of next year. The distribution period would be based on your life expectancy — 29.6 years.
But if you disclaim the inheritance and it passes to the secondary beneficiary, say your 25-year-old niece, the distribution period would be based on her life expectancy — 58.2 years.
That’s almost three decades of additional tax-deferred growth!
There are other reasons to disclaim money, too.
Besides slashing income taxes, an heir may want to say no thanks for the following reasons:
- To benefit another family member, for example, a grandchild who just got married and could make better use of an inherited one-bedroom condo.
- Because the estate consists of undesirable real estate, such as land that is prone to flooding or rental properties that are difficult to maintain and will be tough to sell.
- The beneficiary is involved in a lawsuit or has creditors who could claim the proceeds.
- The beneficiary is a student and the inheritance would affect eligibility for needs-based financial aid.
- The inheritance comes with strings attached, such as getting an MBA or marrying within the deceased’s faith.
- A special needs trust to pay expenses for the surviving spouse is the secondary beneficiary. Assets moved to the trust may be better protected from nursing home costs and other creditors.
- The primary beneficiary doesn’t need the money, and a charity is the secondary. Disclaiming would accelerate the gift to the charitable organization.
I could keep going but here’s the crazier part.
It’s not as simple as a beneficiary saying “Thanks, but no thanks. I’ll give it to someone else.”
The original beneficiary can’t change or alter the other named beneficiaries.
Rather it will pass to the contingent beneficiary just as if the primary beneficiary had died.
If there is no will or secondary beneficiary, state law will determine the next taker.
Moreover, it’s important to follow the precise requirements of a qualified disclaimer.
If the primary beneficiary ignores them, the property will be considered a personal asset that was a taxable gift to the next person in line.
To use a disclaimer, the IRS requires that the person disclaiming the asset:
- Act within nine months of the owner’s death. In the case of a minor beneficiary, the disclaimer can’t take place until the minor reaches the age of majority or the state allows a guardian to act on the child’s behalf.
- Put the disclaimer in writing and deliver it to the person in control of the estate, which is usually the executor or trustee.
- And does not accept or receive any benefit from the disclaimed property.
The disclaimer is irrevocable. So you can can’t go back after a stock market plunge, for example, and reclaim the assets.
Think it might be in your best interest to disclaim part or all of an inheritance? Or would you at least like to have the option?
Then make sure your benefactor names a secondary beneficiary in their wills, trusts, and qualified retirement accounts.
And while you’re at it, go through your listed beneficiaries right now, too. You can always change your mind later.
To a richer life,
Editor, Rich Life Roadmap