Financial professionals generally focus on estate planning issues from the perspective of the grantor. Considering the massive amount of wealth expected to change hands in the coming decade, it’s also important for advisors to address how to best inherit wealth.
This includes the possibility of fully or partly rejecting an inheritance, according to a new analysis by the Colcom Group, a consulting firm.
“When people talk about estate planning, the focus is usually on how to leave assets,” the report states. “Rarely do we talk about the other side of the table — the recipient’s. Yet for heirs, especially those in high-net-worth families, an inheritance isn’t always simple. It can come with its own set of complex decisions.”
One of the lesser-known tools available to heirs is a “qualified disclaimer,” the report explains. While such disclaimers — an irrevocable refusal to accept all or part of an inheritance — are most often discussed in the context of passing down an individual retirement account, they have a variety of potential use cases to consider.
“At first glance, disclaiming an inheritance sounds counterintuitive,” the report notes. “But in specific, well-planned scenarios, a qualified disclaimer can be a deliberate way to manage taxes, protect assets or recalibrate family wealth.”
Rejecting an inheritance is a big step from both a financial and behavior perspective, of course, but doing so can help families retain and more equitably distribute wealth. In all cases, however, it’s important for advisors and their clients to be careful in their communications and execution.
Full or Partial Disclaimer
Many people assume that if they disclaim an inheritance, they must forfeit everything. In reality, the report notes, qualified disclaimers under federal law let a person refuse all or part of a bequest.
“For example, you might disclaim a large retirement account that would push your income into a higher tax bracket, yet still accept real estate or other assets that don’t create the same tax impact,” the report explains. “While disclaimers are often discussed in the context of estate-tax avoidance, they can be just as relevant if you’re concerned about income taxes, asset protection or family wealth distribution.”
The federal criteria for a qualified disclaimer include filing the disclaimer in writing within nine months of the decedent’s death and not accepting any benefits from that asset beforehand. There are also state-level rules and requirements to contend with, so consulting qualified local experts is often advisable.
Where Do the Assets Go?
A disclaimer doesn’t necessarily mean that the asset disappears or goes to the state. In most cases, it passes to the next beneficiary named in the estate plan.
“This can allow assets to stay in the family while avoiding unintended tax consequences or legal exposure,” the report states. “In that way, a disclaimer doesn’t impede the original intent of supporting the next generation and may actually help preserve it.”
Managing Inherited IRAs
As noted, qualified disclaimers are most often considered when a high earner stands to inherit a large individual retirement account subject to strict distribution rules that require most non-spouse beneficiaries to withdraw all assets from an inherited IRA within 10 years.
The report offers an example of a client who is a physician in the 35% marginal bracket, set to inherit a sizable IRA. Generally, distributions from the IRA are going to be taxed as ordinary income.
“Accepting it means you’ll have to draw down the account within 10 years, further inflating your income in years when you’re already near the top bracket,” the report explains. “However, disclaiming that IRA could potentially allow it to pass instead to a college-aged child in a significantly lower bracket.”
Although the child will still probably face a 10-year distribution schedule, their overall tax rate during that period would likely be much lower than the initial heir. As a result, more of the inherited value stays within the family, and the intent of supporting the next generation is preserved.
“Of course, timing is everything,” the report warns. “Under federal law, a disclaimer must generally be filed within nine months of the decedent’s death, and it’s irrevocable. If you take even a single distribution — or otherwise exercise control over the account — you lose the option.”
Estate Tax
Another example in the report points to a client in their late 50s who is already financially secure and is set to inherit $4 million from their parents’ taxable estate.
“On paper, it seems like a gift,” the report notes. “But that gift can also be a tax liability in certain situations. … What if the inheritance increases your total estate above the federal exemption threshold, potentially triggering estate tax when you pass? Currently, that could expose your heirs to a 40% estate tax on the portion above the federal exemption.”
By disclaiming the inheritance, those assets could potentially pass to other heirs, including children, who may be earning less and have estates further from the taxable threshold.
“This scenario is relatively rare and would require professional guidance, but, done properly, it could preserve family wealth instead of eroding it,” the report suggests.
Beyond the Tax Perspective
Other reasons to consider a qualified disclaimer, according to the report, include divorce, litigation or financial instability. Such situations can make it unwise to inherit assets directly. The same principle applies to those facing professional liability, including surgeons, attorneys or business owners with creditor exposure.
“Imagine the issues that could arise if an heir is in the midst of a contentious divorce,” the report states. “Inherited assets are typically considered separate property, but if the heir uses that inheritance to buy a new home, pay joint expenses or deposits it into a joint account, the line between separate and marital property can blur quickly.”
On the other hand, the report explains, disclaiming the inheritance might allow the assets to flow into a trust for the benefit of the heir’s children — but only if the estate plan specifies this outcome. That is, a client who disclaims an inheritance cannot direct where the disclaimed property goes. Instead, it passes according to the terms of the governing estate plan or intestacy laws.
“This type of maneuver requires foresight, strong estate documentation, and an understanding that disclaiming is absolute — once it’s done, there’s no going back,” the report concludes.
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