The new proposal called the “American Families Plan” could end the step-up in cost basis for inherited assets. But, what does this mean for ETF investors? In this post, we discuss some of the key details of this proposed plan. This post is also a reminder to our premium subscribers that the May portfolios are now available.
How have inherited ETFs been taxed up to now?
ETFs owned by retirees typically reside in one of three different kinds of accounts. The Secure Act changed the rules for assets in retirement accounts, like IRAs. I published an article about the reduced benefit of the stretch provision in IRAs recently. In summary, non-spouse beneficiaries must now draw down their IRA assets within 10 years. Previously, beneficiaries could limit their withdrawals to Required Minimum Distributions.
However, the American Families Plan proposes new rules on ETFs inherited from a retiree’s taxable account. Currently, an heir enjoys a full step-up in cost basis on inherited ETFs residing in a taxable account, meaning the heir could immediately sell the ETF and not owe any capital gains tax. For example, suppose a retiree purchased $100,000 of SPDR S&P 500 Index ETF (ticker: SPY) on April 30, 2001, and reinvested all dividends for the next 20 years. On April 30, 2021, the investment would be worth approximately $484,000, not including any taxes due on the dividends generated by holding this ETF.
Selling appreciated ETFs under this new plan
If the retiree sells this ETF investment prior this his or her death, capital gains would be owed on it up to 20% of the $384,000 gain, or $76,800. However, if the retiree passes away, an heir could sell it immediately and not pay any capital gains taxes. The heir received a step-up in cost basis. The new basis is assigned to the day the retiree passed away. However, under the new plan, this step–up is removed, and replaced by a $1,000,000 exemption. So, in the previous example, the heir would not owe any additional taxes. However, as larger sums of ETFs assets are bequeathed, an heir may owe taxes up to the 39.6% rate. And, there is still the estate tax that may apply if the retiree has more than $11.7 million of assets at death for 2021.
Will this plan pass congress?
No one knows yet what will eventually be passed by congress, so it is likely too early to start making any changes to a retiree’s estate. Time will tell how this may or may not impact your ETF assets passed to your heirs.
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