The Problem

• There is more than one tax bill to worry about when your heirs get the IRA. The 2011 federal estate tax rate is 35 percent on estates larger than $5 million. Traditional IRAs also pay income taxes on all distributions, with the highest rate being 35 for top income brackets. Each state has its own estate and income tax issues as well to consider. An completely distributed traditional IRA inherited in a $5 million estate at the top income tax can lose more than 70 percent in taxes. That leaves $300,000 out of a $1 million IRA.
  
  

Taking the Taxes on Yourself

• Taking the money out of the IRA before you die seems to solve the income tax problem to your beneficiaries. This is especially true if you are taking distributions over several years. However, unless you plan to spend the money, your beneficiaries are still going to pay estate taxes on the funds. You are only mitigating income taxes. So consider a couple of things: Will your income taxes be less and will your beneficiaries actually take a lump sum distribution?
  
  

Beneficiary Option

• Beneficiaries are not required to take a lump sum distribution when you die, and not all IRA distributions are taxable. Remember, only traditional IRA distributions are added to annual income. Roth IRAs are not, unless you haven't owned the Roth for five years, then only earnings are added to income. Your beneficiaries have at least three options: a lump sum distribution, a five-year distribution term or to roll the inherited IRA into a beneficiary IRA. Your surviving spouse has one more option, which is to take the IRA on as her own. While you can't dictate the options your beneficiaries choose, if they spread distributions over five years or roll funds into a beneficiary IRA, they reduce income taxes owed the year after you die. The beneficiary IRA preserves the IRA growth structure, only mandating annual required minimum distributions each year based on the beneficiary's age. Beneficiaries are often younger, thus required to take out less.
  
  

Smart Liquidation

• If you truly don't need the IRA assets, there is an option to liquidate that helps preserve the entire value of your estate. If you qualify for life insurance, you can use systematic IRA distributions to fund a life insurance policy. Life insurance goes to beneficiaries tax free. Using the assets of the IRA might fund an insurance policy with death benefits that not only alleviate the income tax burden but also the federal estate tax burden. Taking distributions over time reduces you possible tax bill. Speak with an estate planning specialist to see what options best suit your situation.