IRA Beneficiary
29. Leaving Everything to Your Spouse (Taxes at Second Death)
Sue's estate of $4 million can claim her $2 million exemption. The estate tax bill on the remaining $2 million? $900,000!
Estate taxes are due in cash, usually within nine months of your death. This can be devastating when most of your liquid assets are in tax-deferred plans. Let me explain.
In this case, because there were no other assets available to pay the estate taxes, Bob and Sue's children had to withdraw money from the IRA to pay them. That created an income tax bill-remember, income taxes must be paid whenever you take money out of a tax-deferred plan. Because the estate was in a 35% federal tax bracket, they had to take out another $484,615* to pay the federal income taxes on the money they withdrew to pay the estate taxes!
The problem with leaving everything to your spouse is that you waste the estate tax exemption of the spouse who dies first. Remember, everyone is entitled to an exemption. When Bob left his entire estate to Sue, he wasted his exemption. If they had planned ahead, they could have used both exemptions and saved $1,384,615 in federal taxes!* Here's how.
*NOTES: The beneficiaries would receive an income tax deduction for the estate taxes attributable to the IRA. Also, income taxes will eventually have to be paid when money is withdrawn from the IRA (presumably in smaller increments that will incur less tax). But by using both estate tax exemptions, money will not have to be withdrawn now from the IRA to pay the estate taxes. So neither the $484,615 in income taxes or the $900,000 in estate taxes would have to be paid when the second spouse dies.