Last week we introduced the important distinction between Live On assets — the money you’ll spend during your own lifetime — and Leave On assets — the money you intend to pass on to your children or grandchildren.
Today I want to focus specifically on the Leave On side, because this is where many successful retirees are unintentionally creating a very expensive tax problem for the next generation.
If you have substantial retirement savings in traditional IRAs or 401(k)s that you don’t need to spend during your own lifetime, those accounts are often some of the most tax-inefficient assets you can leave to your kids and grandkids.
Here’s why.
When you pass away, your heirs do not get a step-up in basis on qualified retirement accounts the way they do with taxable brokerage accounts or real estate. Instead, they are forced to withdraw the entire balance over a 10-year period — and every single dollar withdrawn is taxed as ordinary income. On top of that, you already paid taxes on the RMDs during your lifetime.
That means the IRS often ends up taking two full bites at the same dollars.
Real-World Example: The 10-Year Rule Tax Trap
A parent passes away and leaves their adult child a $2 million traditional IRA. The child is currently in the 24% federal tax bracket.
Many heirs try to delay taxes and wait until the final year (year 10) to take the entire balance as a lump sum.
- The IRA grows at a conservative 5% average annual rate for 10 years with no withdrawals.
- By year 10, the account has grown to approximately $3.26 million.
- The heir takes the full $3.26 million in one year.
Adding that to their other income pushes their total taxable income to roughly $3.38 million. This massive lump-sum withdrawal pushes almost the entire distribution into the highest federal tax bracket (37%), plus state taxes.
Result: The heir ends up paying an effective combined federal + state tax rate of approximately 42–46% on the bulk of the money. In total, the IRS and state tax authorities collect roughly $1.35 million – $1.55 million in taxes from that one lump-sum distribution.
You left your kids a $2 million IRA — and the IRS ended up with more than half of it. Is this what you had in mind?
Four Smarter Strategies: The Smart Legacy Tax Shield
The good news is there is a much smarter way. The Smart Legacy Tax Shield is a strategic approach that allows you to handle the tax burden in your generation so your heirs can receive assets with little or no future tax impact.
There are four main ways to implement it, each with its own pros and cons depending on your age, tax bracket, health, and family goals:
1. Spend Down Qualified / Leave Non-Qualified Assets
Prioritize spending from your IRA and other qualified accounts first, while preserving your non-qualified (taxable brokerage or real estate) assets that receive a step-up in basis for your heirs.
Pros: Simple, no new products needed, full step-up in basis for heirs.
Cons: You may pay higher taxes during your lifetime as you draw down the IRA.
2. Roth Conversion Strategy
Convert traditional IRA dollars to a Roth IRA over time, paying the tax now while you’re in a lower tax bracket. Your children then inherit a tax-free Roth account with no 10-year mandatory withdrawal rule.
Pros: Tax-free growth and withdrawals for heirs, no RMDs during your lifetime after conversion, very clean inheritance.
Cons: Requires paying tax upfront, which can be significant if you don’t have cash outside the IRA.
3. Non-Roth Distributions + Reinvestment
Take distributions from the IRA, pay the tax directly from the distribution itself, and reinvest the after-tax proceeds into non-qualified accounts that can receive a step-up in basis for your kids.
Pros: You don’t have to come up with extra cash from other sources to pay the tax (unlike Roth conversions). No new insurance or annuity products required, and heirs get a full step-up in basis.
Cons: You pay tax now and lose the tax-deferred growth on the amount withdrawn and reinvested.
4. Smart Life Insurance Legacy Strategy (Often the Highest Impact)
Take your RMDs, pay the tax, and use the net after-tax cash to fund a life insurance policy. This delivers a tax-free death benefit to your heirs, often replacing — and sometimes exceeding — the value of the original IRA.
Pros: Highest leverage — one dollar of after-tax RMD can create several dollars of tax-free death benefit. Completely removes the IRA tax problem for heirs.
Cons: Requires medical underwriting and ongoing premiums; works best if you are still insurable.
Each of these four strategies has its own advantages and trade-offs, but they all share the same powerful goal: pay tax once instead of twice.
I’ve put together a brand-new guide called the Smart Tax Shield Legacy Playbook that walks through both the tax strategies from last week and these four Legacy Tax Shield options in plain English. It’s available for free download on my website.
Even better, I’m still offering to build your own Smart Retirement Model at no cost or obligation while time slots are available. You’ll see exactly how much of your savings is truly Leave On money and which of these strategies could deliver the best outcome for your family.
Ready to explore what’s possible for your situation?*
Book a quick 15-minute call on my calendar at [LeonardiFamilyWealthcare.com](https://www.leonardifamilywealthcare.com).
There really is a smarter way to retire.