Managing Inherited Wealth: Tax Planning for Beneficiaries of Estates

In our experience, decisions made in the months following an inheritance can carry lasting tax consequences. Tax planning for beneficiaries of estates generally centers on three objectives: identifying which federal and state taxes apply to the assets received, structuring distributions from inherited retirement accounts to help manage marginal tax brackets, and establishing a cash flow strategy before assets are spent or reinvested. For 2026, most heirs are unlikely to face federal estate tax, Colorado imposes no inheritance tax, and the most significant planning variable for many families may be the ordinary income tax attached to inherited IRAs. Because these decisions often involve legal and tax questions, your attorney and tax professional can be valuable partners throughout the process.

According to a Cerulli Associates projection, $124 trillion in wealth will transfer through 2048, with $105 trillion expected to pass to heirs.

When evaluating why estate planning is important, most families focus on the individual drafting the documents. The beneficiaries, however, inherit the resulting tax and administrative framework, which gives them a stake in how those documents are structured. Beneficiary designations determine who receives a retirement account and which distribution rules govern it, while trust provisions determine whether income is distributed to beneficiaries or accumulated within the trust.

Well-coordinated estate planning documents can give heirs a predictable timeline and may help reduce unexpected tax liabilities, which makes tax planning for beneficiaries of estates more effective. Coordination involves time and professional fees, and documents drafted years earlier may not reflect current tax law, so periodic review with the family’s estate attorney can be helpful.

Trust beneficiaries can be particularly affected by drafting choices, because trusts and estates face compressed federal income tax brackets. For 2026, trusts and estates reach the 37% bracket once taxable income exceeds $16,000, while a married couple filing jointly reaches that rate only when taxable income exceeds $768,700. As a result, retained trust income may be taxed at higher rates than distributed income. Trusts may retain income for other reasons, such as asset protection or a beneficiary’s long-term needs, so tax represents one factor among several.

An inheritance may be subject to several distinct taxes, each governed by its own rules. Identifying them is the foundation of tax planning for beneficiaries of estates.

• • Federal estate tax: This tax is assessed on the estate before distribution. Estates of descendants who die in 2026 have a basic exclusion amount of $15 million per individual under the One Big Beautiful Bill Act.
• • Colorado estate and inheritance tax: Colorado replaced its inheritance tax in 1980, and no Colorado estate tax filing is required for deaths after December 31, 2004. Property located in other states may be subject to different rules.
• • Capital gains tax: Inherited property generally receives a basis equal to its fair market value on the date of death, which may eliminate capital gains tax on appreciation accumulated during the decedent’s lifetime.
• • Ordinary income tax: Distributions from inherited traditional IRAs and employer retirement plans are taxable to the beneficiary in the year received.

The following strategies are common considerations for estate beneficiaries. Each involves trade-offs, and we work alongside your CPA or tax advisor and your estate attorney when evaluating which approach may fit your situation.

1. Structure Inherited IRA Distributions

For many heirs, inherited retirement accounts are where tax planning for beneficiaries of estates carries the greatest consequence. Under the SECURE Act, most designated beneficiaries must fully distribute an inherited account by December 31 of the 10th year following the owner’s death. Eligible designated beneficiaries, including surviving spouses, minor children of the owner, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the owner, may qualify for life expectancy payments instead.

When the Owner Had Already Begun RMDs

The 10-year rule does not always allow beneficiaries to wait. Under final IRS regulations published in July 2024, which took effect for 2025, a beneficiary who inherits from an owner who died on or after their required beginning date must take annual required minimum distributions (RMDs) in years one through nine and empty the account by year 10. Whether or not annual RMDs apply, deferring everything to the final year can push a large balance into a single tax year, so spreading distributions across the period may help manage marginal brackets. Earlier distributions also reduce the balance that remains tax-deferred, and future tax rates and income levels are uncertain, so the appropriate pace can vary by beneficiary. Missed RMDs may trigger IRS excise taxes, which makes coordination with your tax professional valuable.

Inherited Roth IRAs

Inherited Roth IRAs are subject to the same 10-year deadline, although annual distributions are generally not required and qualified distributions are free of income tax. Distributions qualify for tax-free treatment only after the original owner’s Roth account has satisfied a five-year holding period, and funds left invested until late in the window remain exposed to market fluctuations.

2. Leverage the Step-Up in Basis

Because inherited taxable assets generally receive a new basis at the date of death, selling shortly afterward often results in minimal capital gains taxes. That can make the months after an inheritance a potentially tax-efficient time to diversify a concentrated position, ideally after reviewing cost basis and tax lots against your time horizon. Selling may also mean giving up potential future appreciation in the original holding, and the step-up does not apply to inherited retirement accounts or certain other assets, so your tax professional can help confirm cost basis before any sale.

3. Coordinate Trust Distributions With Your Tax Bracket

When a trust or estate remains open, the fiduciary files Form 1041. Income distributed to a beneficiary is reported on Schedule K-1 and taxed at the beneficiary’s individual rates, while retained income is taxed within the trust. Distributing income may lower the overall tax bill in some cases, although distributed assets leave the trust’s protections, and distribution decisions depend on the trust’s terms and the trustee’s discretion. We collaborate with the trustee, the estate attorney, and your tax advisor when evaluating distribution timing.

For beneficiaries already in the highest bracket, high income tax planning can help evaluate the timing of distributions.

4. Establish a Tax-Aware Cash Flow Strategy

We generally recommend holding inherited cash in a liquid, conservative account for several months before making long-term commitments.This pause can allow time for thoughtful planning, although cash held for extended periods may lose purchasing power to inflation and may miss potential market gains. A cash flow strategy can then convert these rules into a multi-year schedule, commonly in the following sequence:

● Cash and money market balances can cover near-term liquidity needs.

● Taxable accounts with a stepped-up basis can typically be drawn on next.

● Inherited IRA distributions can be scheduled in lower-income years.

● Inherited Roth IRA balances can often remain invested until late in the 10-year window.

This sequence may vary based on income, tax rates, and goals. Drawing on taxable accounts first can allow retirement accounts to continue growing tax-deferred, while potentially leaving larger IRA distributions for later years within the 10-year window.

For families who wish to support charitable causes, charitable giving strategies can be integrated into the same plan in coordination with your tax advisor and attorney. Charitable strategies may offer tax benefits, although gifts are generally irrevocable and reduce the assets available to the family.

Tax planning for beneficiaries of estates is most effective when inherited accounts, personal income, and long-term objectives are evaluated together.

As fiduciaries operating under a flat-fee model, our wealth advisors sit on your side of the table. Our CFP® professionals provide high net worth financial planning, and our financial planning process can help support developing a distribution schedule and cash flow strategy. For those interested in ongoing portfolio oversight, our investment management services may help, and clients who prefer local guidance can also rely on our investment management in Denver for newly inherited portfolios.

Contact the 5280 Associates team to discuss your inheritance and the decisions ahead.

Disclosures

Notice: The concepts in this blog are intended for educational purposes only. They may not be suitable for your particular situation. The suitability of any specific product or strategy will be dependent upon your particular situation. 5280 Associates and its advisory persons do not provide legal advice, accounting or tax advice. You should consult with your attorney, tax advisor or accountant before implementing any strategy covered in this blog.