What to Spend, What to Leave

The decumulation plan that minimizes your lifetime tax is not necessarily the one that maximizes the after-tax wealth your heirs receive. The two objectives align in most years, but diverge sharply in the last decade of life. The SECURE Act of 2019 and the regulations finalized in 2024 made this divergence sharper by ending the stretch-IRA and replacing it with a 10-year distribution rule under IRC §401(a)(9)(H) for most non-spouse beneficiaries.

Inheritance tax surface, by bucket:

Taxable brokerage

receives a full basis step-up at your death under IRC §1014. The heir inherits assets at fair market value, can sell them immediately at zero capital gains cost, and only owes tax on appreciation that occurs after the date of death. This is the most tax-efficient bequest in the Internal Revenue Code.

Roth IRA

passes income-tax-free to the beneficiary, who must fully distribute the account within 10 years. The distributions themselves are not taxable, and — unlike the pre-tax account below — there are no annual RMDs during those ten years, because a Roth owner is always treated as dying before their required beginning date. The heir can leave the whole balance compounding tax-free and take it in a single distribution in year ten. That structural asymmetry, alongside the complete absence of tax, makes the Roth the second-best bequest; the only cost is the loss of tax-free compounding after year 10.

Pre-tax IRA/401(k)

passes to the beneficiary as ordinary income on the SECURE Act schedule. Most non-spouse beneficiaries are subject to the 10-year rule. The IRS confirmed in 2024 that beneficiaries of an owner who died after their RMD beginning date must take annual RMDs during years 1–9 and fully deplete the account by year 10. A high-earning adult child in their peak career years will inherit this stream at their marginal rate, often losing 40%+ to combined federal and state brackets. This is the worst standard bequest in the code.

HSA

is the most severely penalized inheritance in the code for non-spouse heirs. Under IRC §223(f)(8)(B), the HSA tax wrapper terminates at death, and the entire balance becomes taxable ordinary income to the beneficiary in the year of death, with no 10-year smoothing. (A surviving spouse named as beneficiary is the sole exception: under IRC §223(f)(8)(A) the account simply becomes their own HSA and nothing is taxed. Name your spouse; if there is no spouse, spend it.) Treat the HSA as capital to be fully exhausted during your lifetime, not bequeathed to non-spouse heirs.

Running the conversion one generation up. The bracket arithmetic above works across households, not solely within one, and the version worth knowing runs backwards from the usual direction of family money. An elderly parent sitting on a large pre-tax IRA they are not spending — often reinvesting the RMD instead of consuming it — is holding an asset that will land on their children under the ten-year rule, at those children’s peak marginal rate. If the parent’s own bracket is 12% or 22% and the heir’s will be 37% plus state, converting inside the parent’s brackets is worth an enormous amount at the family level. The obstacle is usually that the parent will not spend their own capital to pay a tax bill whose benefit accrues to someone else — which the child can solve by paying the conversion tax.

Three things to get right before doing this. First, money you hand a parent to pay their tax is a gift to them; the IRC §2503(e) exclusion covers tuition and medical expenses paid directly to the provider and nothing else, so a large conversion tax consumes annual exclusions or lifetime exemption and may need an Form 709 (section “Gift Taxes”). Second, model the parent’s whole return instead of the bracket alone — a conversion that lifts a modest retiree across an IRMAA tier or into the Social Security torpedo (section “The Social Security Tax Torpedo”) can cost more than the bracket saves, and the parent, not you, will bear those costs.

Third, and the reason this stays a niche technique: you are paying tax on an asset you do not own and may not inherit. The parent may need the money, may change the beneficiary designation, may remarry, may require Medicaid-level care, or may simply leave the account split among siblings who contributed nothing — in which case you funded their inheritance. There is no clean way to secure the arrangement, because any enforceable string turns the “gift” into something else. Do it where the relationship and the estate documents are both settled, size it to what you can afford to give unconditionally, and get every potential heir in the same conversation first. Where those conditions do not hold, the bottom line is that the tax saving is real and the technique is still not for you.

The reordering this implies for late-life spending:

• Spend the HSA balance during your lifetime against accumulated medical receipts. Never let it pass to a non-spouse beneficiary.
• Spend pre-tax balances aggressively. Every dollar you withdraw and consume at your lower retirement bracket is a dollar your heir will not have to withdraw at their peak-earning marginal rate. Prioritize pre-tax assets for charitable QCDs and regular consumption.
• Preserve the Roth IRA. It continues to compound tax-free for you and remains tax-sheltered for another 10 years in your heir’s hands.
• Leave highly appreciated taxable assets untouched to secure the basis step-up. Selling a position with a 5x embedded gain at age 80 to fund a Roth conversion is often a massive strategic error; the step-up at death erases that entire embedded tax liability forever.

Coordinating with the estate plan If your estate plan directs a portion of your estate to charity, name the charity as a direct beneficiary of your pre-tax IRA. The charity is tax-exempt and will inherit the IRA without paying a single dollar of income tax. This is the most efficient way to extinguish an oversized pre-tax account at death. Combined with lifetime QCDs, pre-tax accounts should serve as your primary charitable vehicle, leaving your Roth and stepped-up taxable accounts for your family. For basis step-up choreography and trust workarounds, see chapter “Estate planning”.