Why it matters what assets you leave to heirs

Ask NJMoneyHelp

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Q. I’m trying to divide my assets for my three children for when I die someday. My 401(k) is worth about the same as my house, and I have a taxable account worth about the same also. Should I just make each kid the beneficiary for one account or should they all receive a third of each asset?
— Mom

A. Splitting assets in the way you suggest will cause a lot of problems if you want to treat your three children equally.

While the assets may be worth the same amount today, it will be very difficult for you to ensure that the situation doesn’t change as the investment and real estate markets do not move in lock-step, said Andrew Novick, a certified financial planner and estate planning attorney with The Investment Connection and Brookner Law Offices in Bridgewater.

Plus, he said, you may need to tap your investment accounts to cover your living expenses in retirement, which will also affect the value of these accounts.

That means it’s highly unlikely that your approach will result in each child’s inheritance being of equal value.

Inheriting a taxable account is fairly straightforward, Novick said.

“The account can easily be retitled to the heir’s name and assets in the account get a step-up in cost basis to the date-of-death value,” he said. “The step-up in basis allows the heir to sell any holding in the account soon after your death with essentially no income tax consequence so the proceeds can be used as he sees fit.”

It’s not that simple for the house or the 401(k).

For the house, it’s important to know if the child inheriting the house has the desire and/or financial resources to keep the house as his own residence, if the house would be converted into a rental property or if it would be sold.

Then you’d need to decide if the child inheriting the property would be responsible for the costs to maintain the property or if the costs would be shared by all of your heirs, Novick said.

“Unlike investment accounts, which generally consist of marketable securities and can be easily valued on a daily basis, an appraisal is needed to determine the value of the house,” he said. “If the house is going to be sold, the actual sales price may deviate from the appraised value – it could be more if there is a bidding war or less in a weak real estate market.”

Plus, he said, selling a house typically involves incurring realtor, attorney and other closing costs that don’t apply to the 401(k) or taxable account. Note that you can include a clause in your will regarding these issues, but it will likely only complicate a situation that you are trying to keep simple.

Now, the 401(k). A 401(k) is controlled by a beneficiary designation and not the will.

“Whoever inherits the 401(k) will have to coordinate with the 401(k) provider on their options, which generally include leaving the account with the 401(k) provider, taking a lump sum, taking an annuity payout, or rolling over the account into an Inherited IRA, he said.

Also, assets in the 401(k) or Inherited IRA are tax-deferred, which is a huge advantage for long-term investors. But any distributions out of these accounts, including taking a lump sum or annuity payout, are generally considered taxable income, Novick said.

Depending on your heirs’ financial situations, inheriting the 401(k) could fit in nicely with their retirement planning or pose an unfair tax burden, especially if they need to access the account now, Novick said.

“The heir/beneficiary of the 401(k) or Inherited IRA is responsible for withdrawing a Required Minimum Distribution (RMD) out the account each year or face a stiff IRS penalty,” Novick said. “While relatively easy to comply, heirs to the taxable account or house simply don’t have to contend with a similar matter.”

Instead, Novick said, the best approach is to simply split each asset equally among your children to make sure they’re each treated the same.

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