If you have a sizable traditional IRA or 401(k) that you do not need to spend in retirement, leaving that account to your children can be a costly way to pass money to the next generation.
Not because they will not inherit it. They will, if they are named as beneficiaries. The problem is what happens next. Under current rules, most non-spouse heirs must empty an inherited traditional IRA within 10 years. Those withdrawals are generally taxed as ordinary income, often during the child’s peak earning years.
A traditional IRA is tax-deferred, not tax-free. You pay tax on the dollars you withdraw while you are alive. Whatever is still in the account when you die is still pre-tax. Your children generally must empty that remaining balance within 10 years, and those withdrawals are taxable to them as ordinary income. The family can face a large tax bill across two generations. That is different from the same dollars being taxed twice.
Why an inherited IRA is often a tax-inefficient gift
Unlike a taxable brokerage account or real estate, a traditional IRA does not receive a step-up in basis at death. Your children inherit the remaining pre-tax balance — and the tax that comes with it.
Here is a simplified example. You leave a $1.5 million traditional IRA. Over 10 years, that account grows to about $2.1 million. If your child is in a combined federal and state bracket of 35% to 40%, the tax on those withdrawals can land between $700,000 and $850,000.
You thought you were leaving $1.5 million. A large share of the grown account may go to taxes before your children keep it.
The contrast with your own withdrawals matters. Many retirees take only RMDs, often starting around 4% of the balance. Heirs who empty the account over 10 years may withdraw far more each year, on top of their own earned income. That can push them into a higher bracket than you were paying. That is not family tax planning.
In larger examples of $2.5 million, $3 million, or $3.5 million, the tax across both generations can exceed seven figures. Naming your child as beneficiary does not mean they keep most of what remains.
Start with one question: whose taxes are you trying to reduce?
Before any strategy, decide this:
Are you trying to save taxes for yourself, or for your kids?
You usually cannot maximize both. If you defer taxes as long as possible, your heirs often inherit a larger pre-tax account. If you pay more tax now so they inherit cleaner assets, you give up some of that money while you are still here.
That choice becomes clearer when you separate your portfolio into two groups.
Live-On assets are the dollars you expect to spend during your lifetime: living expenses, travel, healthcare, and help you give while you are still here.
Leave-On assets are the dollars you do not need for bills and ultimately intend to pass to children or grandchildren.
Most people never make that split. They use the same allocation, the same withdrawal plan, and the same tax strategy for every retirement account, then assume “whatever is left goes to the kids.” Once you identify the Leave-On portion, better options appear.
For the full 10-step framework behind this kind of planning, see my book, [*A Smarter Way to Retire: 10 Steps Towards a Confident Financial Future*](https://www.leonardifamilywealthcare.com).
Four strategies for Leave-On IRA dollars
These are planning concepts, not one-size-fits-all recommendations. The better path depends on your tax bracket, your heirs’ likely brackets, cash flow, health, and goals. A detailed cash flow and tax model is how you compare them. Trying to do this without a model is like driving at night with no headlights.
1. Spend the IRA first and preserve better assets
If you need savings for living expenses, using the traditional IRA first can help preserve taxable brokerage accounts and real estate. Those assets may receive a step-up in basis at death, which can wipe out decades of capital gains for heirs.
This can be especially useful if you are in a lower bracket than your working children. You are retired. They may still be in peak earning years.
**Limitation:** This helps when the money is truly Live-On. It does not solve the tax problem on IRA dollars you never intend to spend.
2. Use strategic Roth conversions
Convert portions of the IRA to a Roth while you are still in a relatively lower bracket. Your children may then inherit a Roth rather than a taxable IRA.
This only makes sense if paying tax at *your* rate now is likely better than having *them* pay tax later. Watch IRMAA and current-year brackets. A model helps you see how much to convert, and when.
**Trade-off:** You pay the tax now. Many people dislike writing that check, even when it may help the family over time.
For a deeper look at conversion mechanics, download the [Roth IRA Conversion Playbook: 2026 Edition](https://www.leonardifamilywealthcare.com/roth-ira-conversion-playbook).
3. Take distributions and reinvest the net amount
Take money you do not need from the IRA, pay the tax, and reinvest what is left in a taxable brokerage account. That new account may later receive a step-up in basis.
This is a tax-rate decision between generations: is it cheaper for you to pay the tax now, or for your kids to pay it later?
**Trade-off:** You give up future tax-deferred growth on the amount withdrawn, and you still pay tax today.
4. Smart Legacy Tax Shield
This can be a high-impact option when a large IRA is true Leave-On money and the owner can qualify. You take distributions or RMDs, pay the tax, and use the net amount to help fund a life insurance policy. Your children may then receive a tax-free death benefit instead of a taxable IRA with a 10-year withdrawal rule.
In some modeled cases, the tax-free benefit may be comparable to, or greater than, what heirs would have kept after income taxes on the inherited IRA. Results vary. Life insurance is a long-term product, subject to underwriting and to the claims-paying ability of the insurer. It is not appropriate for everyone, especially if health is an issue.
I recently reviewed a couple in their 70s with about $2.4 million in traditional IRAs. After modeling, roughly $1.1 million looked like Leave-On money. In that illustration, doing nothing pointed to a projected tax hit of well over $800,000 across the 10-year window, including growth. Repositioning a portion of those dollars through a Legacy Tax Shield approach was designed to help the next generation keep more after tax, while still protecting the parents’ lifetime income and lifestyle. This is a hypothetical illustration, not a typical result.
That is the point of treating Leave-On money differently.
The [Smart Tax Shield Legacy Playbook](https://www.leonardifamilywealthcare.com) walks through these ideas in plain English. If you want a copy, reach out or look under Books and Guides on the website.
Why most families never fix this
Three reasons come up again and again:
1. They do not realize how large the tax bill can be for their kids.
2. They never separated Live-On assets from Leave-On assets.
3. They assume the kids will “just deal with it.”
Once the numbers are on paper, the motivation to choose a path usually follows.
What to do next
If a large traditional IRA is sitting in the Leave-On column, leaving it untouched may be less tax-efficient than other options. Decide whose taxes you are trying to reduce. Separate Live-On money from Leave-On money. Then compare the four paths with real numbers, not guesses.
I am still offering to build a complimentary Smart Retirement Model while openings remain on my calendar. We can look at how much of your portfolio is Live-On versus Leave-On, and how these strategies could affect you and your heirs.
Book a short call at [LeonardiFamilyWealthcare.com](https://www.leonardifamilywealthcare.com). Look for the Contact and Calendly links.
There really is a smarter way to retire.
*This article is for educational purposes only and should not be considered tax, legal, or investment advice. Annuities and life insurance are long-term products with limitations and are subject to the claims-paying ability of the issuing company. Please refer to the website for full disclosures and additional resources.*