How Does Your Estate Pass to Your Heirs?

Your estate passes to your heirs through four main mechanisms: beneficiary designations on retirement accounts and life insurance (pass directly), joint ownership of assets (passes automatically to the survivor), trusts (pass per trust terms, avoiding probate), and the will (governs everything else, requires probate). The 2026 federal estate tax exemption is $15 Million per person, meaning most estates owe no federal estate tax, but inherited retirement
accounts can still create substantial tax exposure for heirs under the 10 year distribution rule.

Key Takeaways:

– The 2026 federal estate tax exemption is $15 Million per person, or $30 Million for a married couple, per the IRS.

– Beneficiary designations on retirement accounts override the will. Outdated beneficiaries cause the most common estate mistakes.

– The 10 year rule requires non-spouse beneficiaries to distribute inherited IRAs within 10 years of death.

– Trusts can avoid probate, provide control, and protect assets, but require setup and ongoing maintenance.

– State estate taxes apply in some states regardless of the federal exemption.

How does an estate pass to heirs?

Four mechanisms govern how property transfers at death:

1. Beneficiary designations on retirement accounts, life insurance, and some bank accounts pass directly to named beneficiaries, bypassing the will and probate.

2. Joint ownership with right of survivorship passes the asset automatically to the surviving owner.

3. Trust ownership passes according to the trust terms, also bypassing probate.

4. The will governs everything not covered by the first three categories. Assets passed by will require probate.

Most affluent estates use a combination of all four mechanisms.

What is the difference between a will and a trust?

A will is a written document specifying how assets should be distributed at death. It requires probate, which is the court-supervised process of validating the will and overseeing distribution.

A trust is a legal entity that holds assets during life and after death. Assets in a trust pass according to the trust terms without probate.

Key differences:

Most affluent households use both: a trust for major assets and a “pour-over” will to catch anything not in the trust.

What is probate and how do you avoid it?

Probate is the court-supervised process of validating a will, paying creditors, and distributing assets to heirs. It’s public, can take 6 to 18 months, and typically costs 3 to 7 percent of the estate in legal and court fees depending on state.

Probate is avoided by:

– Using beneficiary designations on retirement accounts and life insurance

– Holding assets jointly with right of survivorship

– Holding assets in a revocable living trust

– Using transfer-on-death (TOD) or payable-on-death (POD) designations on accounts where available

For estates of significant size, avoiding probate saves time, money, and privacy.

How do beneficiary designations work?

Beneficiary designations on retirement accounts, life insurance, and certain bank accounts override the will. The asset passes directly to the named beneficiary regardless of what the will says.

This creates the most common estate planning mistake: outdated beneficiaries. A retiree who named an ex-spouse as the IRA beneficiary 30 years ago and never updated it might pass that IRA to the ex-spouse instead of the current spouse or children.

Beneficiary review should happen every 3 to 5 years and after any major life event (marriage, divorce, birth, death).

What is the 2026 estate tax exemption?

The IRS sets the 2026 federal estate tax exemption at $15 Million per person. A married couple can shield up to $30 Million from federal estate tax with proper planning.

The exemption was made permanent and increased to $15 Million per person by the One Big Beautiful Bill Act passed in 2025. Future inflation adjustments will continue.

For estates above the exemption, the federal estate tax rate is up to 40 percent on the excess. For most retirees, even those with $5 to $10 Million estates, federal estate tax is not the issue. The bigger issue is income tax on inherited retirement accounts.

How are inherited IRAs taxed?

Spouses inheriting an IRA can roll it into their own IRA and treat it as their own. Required minimum distributions follow the surviving spouse’s age, not the deceased’s.

Non-spouse beneficiaries inheriting a traditional IRA after January 1, 2020 are subject to the 10 year rule.

What is the 10 year rule for inherited IRAs?

Under the SECURE Act, most non-spouse beneficiaries must distribute the full inherited IRA within 10 years of the original owner’s death.

For traditional inherited IRAs, those distributions are taxable as ordinary income to the heir. For adult children in peak earning years inheriting a large traditional IRA, the forced distributions often hit at top tax brackets.

A $1 Million inherited traditional IRA might net only $600,000 to a 50-year-old heir in the top tax bracket after federal tax alone. The same $1 Million inherited Roth IRA nets nearly $1 Million.

Exceptions to the 10 year rule include:

– Surviving spouses

– Minor children of the original owner

– Disabled or chronically ill beneficiaries

– Beneficiaries less than 10 years younger than the original owner

How do you minimize taxes for your heirs?

Three primary strategies:

1. Roth conversions during your lifetime. Pay the tax during your lower-income retirement years instead of forcing your heirs to pay at their higher rates. See When Should You Do a Roth Conversion?.

2. Spend traditional IRA first. Use the traditional IRA in retirement so heirs inherit Roth and taxable accounts (which get a step-up in basis) instead of traditional accounts.

3. Life insurance for liquidity. A life insurance policy can fund estate taxes, equalize inheritances among children, or replace assets being passed differently.

For estates with significant traditional retirement accounts, the Roth conversion strategy can shift hundreds of thousands of dollars from heir tax payments to family wealth.

What about state estate taxes?

Some states have their own estate taxes with much lower exemptions than the federal $15 Million. As of 2026, states with estate or inheritance taxes include:

– Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and Washington D.C. (estate tax)

– Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania (inheritance tax)

For residents of these states, additional planning may be required. For some affluent retirees, this is one reason for considering a move to a no-estate-tax state.

Common Mistakes:

1. Outdated beneficiary designations on retirement accounts

2. Failing to fund the revocable trust after creating it (very common)

3. Holding all retirement assets in traditional accounts with the 10 year rule looming

4. Skipping life insurance review during pre-retirement planning (see What Should You Do in the 5 Years Before You Retire?)

5. Ignoring state estate tax exposure