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Plan for the Long Term
Dear Jeff:
What does IRD mean when it comes to retirement savings? Our financial advisor brought this up recently and we are not sure what he meant.
Jeff Says:
IRD is the acronym for "Income in Respect of a Decedent" and refers to items for which income taxes must still be paid despite the death of the person who earned it. There are two important principles with which you must be familiar. First, most individuals pay taxes on income in the year that it is received. This is the cash method of accounting. Second, a tax year ends on the date of death. IRD refers to the income that a decedent has earned or has a right to receive, but has not actually received. IRD items include unpaid salary owing at death, interest on U.S. savings bonds that was not taxed as it accrued and qualified plan and IRA distributions to survivor beneficiaries, just to name a few. Simply put, income taxes must still be paid on IRD items despite the death of the person who earned it.
An illustration might help. Let's say that I get paid by my employer on the last day of every month and, suddenly, I died on the 25th prior to receiving my salary check. I earned my salary for the 25 days up to my death, but I had not yet been paid for the days worked. Nevertheless, when my employer sends my check to the personal representative of my estate, my representative must include that IRD item on the income tax return of my estate. Clear as mud, right?
Your financial advisor used the term IRD in reference to your retirement savings. Upon your death, the plan assets will be paid to your named beneficiary. However, that beneficiary will have to pay income taxes on the amount received. By the way, the plan assets will also be included in your estate for federal estate tax and inheritance tax purposes.
Compare this to a highly appreciated asset that you may own. If you were to sell it today, you would pay a capital gains tax on the amount of your profit. However, if you were to die owning that asset, your estate would receive a new basis in the property equal to the value as determined on the day of your death. Therefore, if the estate sells it for that "stepped up" value, it will not have a gain and, of course, would not have to pay any capital gains tax. Thus, the full amount can be distributed to your heirs. Clearly, IRD can make a big difference to your heirs and should be considered when preparing your estate plan.
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