Passing On Wealth Tax-Efficiently

Most families will never owe federal estate tax, yet many still lose a large share of what they pass on to tax, through the income tax on inherited retirement accounts, the capital gains tax on assets given away at the wrong time, and state estate and inheritance taxes that start at far lower amounts. This chapter explains which taxes apply when wealth passes to the next generation, the 2026 thresholds, the one trade-off that drives most decisions (give now or leave at death), and the tools wealthier families use. Trusts and business transfers need an estate attorney; the aim here is to help you know which questions to bring.

The taxes that apply when wealth changes hands

Federal estate and gift tax. One combined system taxes large gifts made during life and the estate left at death. For 2026 each person can pass $15,000,000 free of the tax, counting taxable lifetime gifts and the estate together; above that the rate is 40%. The law passed in 2025 made this exclusion permanent and indexes it to inflation, so the much-discussed drop at the start of 2026 did not happen. A married couple can pass twice the exclusion: anything left to a spouse who is a US citizen is untaxed, and a surviving spouse can keep the unused exclusion of the first spouse to die, but only if an estate tax return is filed on time after the first death, even when no tax is owed. The estate tax calculator shows where an estate stands.

Income tax on inherited retirement accounts. A traditional IRA or 401(k) has never been taxed, and the heir pays ordinary income tax on every dollar they withdraw. Most non-spouse heirs must empty the account within ten years, which can push a working heir into a high bracket. A Roth account, by contrast, passes income-tax-free.

State estate and inheritance taxes. About a dozen states and the District of Columbia levy their own estate tax, some with exclusions far below the federal one, and a handful levy an inheritance tax on the people who receive the money, at rates that depend on their relationship to the person who died. Where you live, and where any real estate sits, can matter more than the federal rules.

Generation-skipping transfer tax. A separate tax applies to transfers to grandchildren or later generations, with its own exemption equal to the estate tax exclusion. It matters mainly for trusts meant to last more than one generation.

Step-up in basis: the rule that favours waiting

When someone dies, most assets they owned outside retirement accounts take a new cost basis equal to their value on the date of death. The growth during their lifetime is never taxed. A gift during life works differently: the person receiving it takes over the giver's original cost basis, and owes tax on the whole gain when they sell.

That creates the central trade-off of wealth transfer. Giving early moves future growth out of a taxable estate. Holding until death erases the capital gains tax on growth already earned. For a family well below the estate tax exclusion, the step-up usually wins, and it rarely makes sense to give away shares with a large unrealised gain; give cash or high-basis assets instead. For a family above the exclusion, the estate tax at 40% usually outweighs the capital gains tax at 15% to 23.8%, and moving growth out early pays.

Lifetime gifts: the annual exclusion and the value of starting early

Each person can give up to $19,000 a year to as many recipients as they like without using any of their lifetime exclusion or filing a gift tax return. A married couple can give twice that to each recipient by electing to split gifts, which does require a return. Separately, paying someone's tuition directly to the school, or their medical bills directly to the provider, is not a taxable gift at any amount.

The value of a gift is not only its size today; it is all the growth that will happen outside your estate.

A gift of $100,000 that grows at 6.0% for 25 years becomes about $429,187. Only the original gift counted against the giver's exclusion; the $329,187 of growth was never part of their estate.

Steady gifts within the annual exclusion add up the same way. Giving $1,500 a month for 20 years moves $360,000 out of an estate without using any lifetime exclusion; invested, it becomes about $680,158 for the recipient. A 529 education plan is a common destination, and the law allows five years of annual exclusion gifts to be made to a 529 at once.

Trusts and other tools, in plain terms

Revocable living trust. Avoids probate and keeps the estate's details private, but saves no tax: the assets are still yours for tax purposes.

Irrevocable life insurance trust. Holds a life insurance policy so the payout is not counted in your estate. Useful when insurance is meant to pay an estate tax bill or provide for heirs.

Grantor retained annuity trust. You put assets in, receive fixed payments back for a set term, and anything the assets earn above an interest rate set by the IRS passes to your heirs with little or no gift tax. It works best with assets expected to rise sharply.

Charitable lead and remainder trusts. A lead trust pays a charity for a period and then passes the rest to heirs at a reduced gift or estate value; a remainder trust does the reverse, paying you an income and leaving the rest to charity, with a deduction now.

Intentionally defective grantor trust and dynasty trusts. The first lets you sell assets to a trust whose income you keep paying tax on, which itself moves money to heirs tax-free; the second keeps wealth in trust for several generations, using the generation-skipping exemption. Both are for very large estates and need specialist advice.

A family business. A buy-sell agreement, often funded with life insurance, sets the price and buyer in advance so the business is not forced into a sale to pay tax. Estates where a business makes up a large share may be able to pay estate tax in instalments over many years.

Beneficiary forms and account choices that cost nothing

Retirement accounts, life insurance and many bank and brokerage accounts pass by beneficiary designation, not by your will. An out-of-date form overrides a new will. Because heirs pay income tax on traditional accounts but not on Roth accounts or stepped-up taxable investments, a few choices can lower the family's total tax: leaving traditional IRAs to heirs in lower brackets or to charity, which pays no income tax, and leaving Roth accounts and taxable investments to heirs in high brackets. Roth conversions during your lifetime, at your tax rate, can also cost less than your heirs' tax at theirs.