An Individual Retirement Arrangement (IRA) may be a vehicle available to Kentucky residents to avoid Kentucky’s inheritance tax. The Kentucky inheritance tax is payable by the beneficiaries of a person’s estate, depending on what the beneficiary received and the relationship of the decedent to the beneficiary.
“Class A” beneficiaries are exempt from the inheritance tax and include parents, surviving spouses, siblings (whether full or half), children (including adopted children and stepchildren), and grandchildren.
“Class B” beneficiaries enjoy a partial exemption from the tax and include aunts, uncles, nephews and nieces (including by the half), daughter-in-laws, son-in-laws, and great-grandchildren (including those who are the grandchildren of adopted children and stepchildren).
All other beneficiaries are considered “Class C” beneficiaries and are afforded a nominal exemption from the inheritance tax. With the highest rate of Kentucky’s inheritance tax being 16%, Class B and Class C beneficiaries may take a big hit if they inherit any sizable amount from the decedent’s estate.
Here is where planning opportunities arise using IRAs.
In Kentucky, IRAs are excluded from the inheritance tax if certain conditions are met, including the requirement that the beneficiary is paid in the form of annuities rather than a lump sum. The term “annuity” under the relevant Kentucky statute is defined as an “annuity contract or other arrangement providing for a series of substantially equal periodic payments to be made to a beneficiary (other than the executor) for his life or over a period extending for at least 36 months after the date of the decedent’s death.”
Therefore, if an IRA is paid to the beneficiary upon the IRA owner’s death over a 36-month or longer period or for the life of the beneficiary, the value of the “annuities” are excluded from Kentucky inheritance tax.
So for Class B and Class C beneficiaries, Kentucky inheritance tax can be avoided by leaving an IRA to such a beneficiary, rather than, for instance, a cash bequest or a real property devise. However, the beneficiary may receive the proceeds in a lump sum, which would be subject to inheritance tax. The owner of the IRA needs to do these two things:
- review the beneficiary payout provisions of his or her IRA, and
- mandate that the beneficiary of the IRA is to receive the IRA funds over at least a 36-month period or for the beneficiary’s lifetime.
A qualified and knowledgeable estate planning attorney can guide individuals with respect to these issues and may be able to save the beneficiary a significant amount of tax at the decedent’s death by advising the beneficiary to elect to take the IRA in the form of 36 or more equal payments (i.e. “annuities”) if proper planning was not achieved beforehand.
Other qualified retirement benefits, such as an Employee Stock Ownership Plan (ESOP) or a qualified profit-sharing plan, while possibly being excluded from Kentucky’s inheritance tax, may be taxable to the beneficiary depending on how the plan mandates payments to be made to the participant and the beneficiary at the participant’s death. For instance, an ESOP of which an individual is a participant may mandate that the ESOP account is to be paid in a lump sum to the individual’s beneficiary upon the individual’s death.
Upon the individual’s retirement, the individual would need to rollover the ESOP into an IRA and make the arrangements discussed above so the beneficiary could take advantage of the exclusion from inheritance tax upon the decedent’s death. Again, these considerations are only relevant to Class B and Class C beneficiaries, but individuals are urged to seek the review of a qualified estate planning attorney to determine if his or her estate plan may be revised to avoid, whether in part or in full, Kentucky inheritance tax.
If you need advice from an attorney, our firm would like to talk to you. You can reach attorney Nathan Vinson at (270) 781-6500 or email@example.com.