To determine the heir’s inheritance, we use the term terminal wealth (W), which is the sum the retirees tax-deferred (WIRA), tax-exempt (WRoth), and taxable brokerage accounts (Wbrokerage). This formulation for inheritance is very similar to DiLellio and Ostrov’s (2018) award-winning paper Constructing Tax Efficient Withdrawal Strategies for Retirees with Traditional 401(k)/IRAs, Roth 401(k)/IRAs, and Taxable Accounts.
W = α(1-τheir)WIRA + αWRoth+Wbrokerage
Here, the variable α is the additional value for the heir due to the ability to stretch the IRA withdrawals over 10 years. In forthcoming research, based on the SECURE act passed on December 17, 2019, we quantify the value of α to be about 1.14 for an heir wishing to stretch their IRA Required Minimum Distributions (RMDs) over 10 years.
The term τheir represents the heir’s marginal income tax rate. For heirs who are high income earners, this rate can be above 30%. For qualifying charitable organizations, this rate is typically 0%. So, by considering the heir’s tax rate, their inheritance can be boosted by having the retiree only withdraw tax-deferred account assets up to, but not exceeding, the heir’s tax rate each year.