When you receive an inheritance via a will, such as a house or cash, or as a beneficiary of an IRA or 401(k), or an estate, you can say thanks but no thanks and refuse it by disclaiming. The inheritance then passes to the next beneficiary, altogether bypassing the person who disclaims. Disclaiming is an interesting mechanism to achieve financial goals for the disclaimer and/or the next heir(s) in line.
Disclaiming an inheritance is not typical. That’s because, one, most people are unaware that they can disclaim, two, it’s only appropriate in certain situations, and three, how often does someone say no to an inheritance?
Why disclaim?
The five reasons one would choose to disclaim are to save taxes, protect assets, avoid additional costs, provide gifts, correct unintended consequences, or some variation/mixture of the five.
1. Reduce the size of your estate
The federal estate tax exclusion is $12.92 million per individual or $25.84 million per couple (2023). Not many individuals or couples have estates valued that high. However, if you live in a state with an estate or inheritance tax, they are different; disclaiming may be a good strategy. Please note an estate tax taxes the decedent’s estate, and an inheritance tax taxes the recipient. Only one state, Maryland, has both! Check the Tax Foundation to find out what your state has.
If you’re subject to either the federal estate tax or state inheritance or estate taxes, then yes, it may make sense to disclaim an inheritance and let it pass to the next beneficiary in line if they’re taxed at lower rates.
2. Prevent higher current taxation
If you’ve been left an IRA or other income-producing asset and accepting it will bump you into a higher tax bracket, and you’re in a position not to need it, then filing a disclaimer could benefit you and the next heir in line. This is especially true if that person is in a lower tax bracket, or in the case of an inherited IRA or annuity, younger AND in a lower tax bracket. They can stretch out distributions over a more extended period. Read my blog posts about Inherited IRA and Inherited Annuity options to learn more.
3. Gifting
Maybe you feel generous and want to make a gift. Disclaiming is an efficient way to do that.
Everyone has an annual gift exclusion of $17,000, or $34,000, if married and decide to team up on the gift (2023). You must file a gift tax return if you give gifts more than the annual exclusion amount. That doesn’t mean you’ll owe tax because everyone has a lifetime exclusion of $12.92 million (2023), which equals the estate tax exemption.
The point here is you can use disclaiming to give a gift but not have it count as a gift and not have to file a gift tax return. Does that make sense? If you want to learn more, read my post Understanding the Gift Tax.
4. Correcting gifts
Sometimes the best intentions go awry. A disclaimer can help realize the original intent by making it more equal for all beneficiaries.
For example, Mary stipulated that stocks A-M were left to her son in her will, and stocks N-Z went to her daughter. Between the time the will was written and Mary’s passing, so many mergers and spin-offs caused the various companies to change names. Her son, who inherited stocks A-M, was left with a much lower inheritance than her daughter, who inherited stocks N-Z.
That was not the original intent. If the daughter felt bad for her brother, and if he was the next beneficiary in line (critical point), she could choose to disclaim some of the stocks to try to equal out their inheritance. If she dislikes her brother, it’s too bad for him. It’s her prerogative to disclaim. Estate issues like this also speak to the larger point of proper estate planning so something like this doesn’t happen.
5. Asset protection
Disclaiming gets tricky regarding asset protection, not that it’s a piece of cake for the previous reasons mentioned above, but when you’re planning your estate, a disclaimer can be incorporated to protect assets.
Wills can be designed to allow the surviving spouse to disclaim the assets. The assets then move into a protected trust for the surviving spouse, allowing the survivor (and heirs) to benefit from the assets, but have them sheltered from future creditors and any potential future remarriages.
I’m going to stop right here. Otherwise, we’ll end up in the weeds of estate planning. I want you to know that disclaiming can be an appropriate strategy for estate planning. Still, you need to seek the advice of an estate planning attorney specializing in this strategy.
Disclaiming consequences – it’s not all about you!
We covered the various reasons why you might want to disclaim an inheritance, but I hate to break to you. It’s not all about you. You have to consider the consequences of your disclaiming decision and understand the limitations.
How does this disclaiming affect the next recipient?
You need to carefully assess if disclaiming that property is also in the best interest of the next recipient. If the next beneficiary in line is receiving government aid, school aid, or Medicaid, for example, an inheritance can reduce or eliminate the subsidy.
That may or may not be a bad thing. When disclaiming, it can’t just be an analysis of your situation but also needs a review of the next beneficiaries. You have to look at the bigger picture.
You’re not in charge
If you disclaim, who’s next in line to inherit the assets? Are there contingent beneficiaries? If the decedent did not specify another beneficiary, the assets might go to whoever gets the rest of the estate. If there were no will, the state intestacy laws would apply. You, the disclaimer, cannot direct who will receive the inheritance.
No going back
Disclaiming is a permanent decision. There are no do-overs. It’s critical to consider disclaiming carefully. Can you afford to pass up the inheritance, and are you 100%, without a doubt, confident it is the best financial move? Once you disclaim, you have no recourse to change your mind.
A disclaim doesn’t have to be all or nothing
The beneficiary can disclaim only a portion of an inherited IRA or asset, allowing some to flow to the contingent beneficiary(s). Partial disclaiming is either a specific dollar or percentage amount as of the date of death.
However, when done this way, all income attributable to the disclaimed portion must also be disclaimed. If the asset’s value was $250,000 on the date of death, and the primary beneficiary disclaimed 50%, then the primary beneficiary would receive $125,000 plus the gains or minus the losses based on that amount. The balance will go to the next beneficiary(s).
How to disclaim?
Even though it’s a simple idea and relatively straightforward, there are specific rules and steps you must take to complete a disclaimer.
- The disclaimer must be in writing: A signed letter by the person doing the disclaiming, identifying the decedent, describing the asset to be disclaimed, and the extent and amount, percentage or dollar amount, to be disclaimed, must be delivered to the person in control of the estate or asset, such as an executor, trustee, or custodian. Contacting the responsible party before sending the letter to verify any additional requirements is always a good idea. You need to avoid any confusion. Usually, it must be either notarized or court-approved. Check with your attorney.
- There is a time limit: The disclaimer must be completed within nine months of the decedent’s passing or nine months after you turn 21 if you’re a minor.
- Do not accept any benefit from the asset you’re disclaiming: Keep your hands off that asset while weighing the decision. Generally speaking, you cannot use or receive the benefits of the inheritance and then later disclaim it. Although there is one exception…
The inherited IRA disclaim (temporary) exception
What happens when you’re the primary beneficiary of an IRA, the decedent was over 72 (2022) or 73 (2023), meaning subject to the Required Minimum Distribution (RMD) rules, AND has not taken their RMD in the year they passed?
For example, the IRA owner dies in October but has not received his RMD for the year. The beneficiary is required to take the RMD before 12/31. Doesn’t that mean they have received a benefit and cannot disclaim? Nope. Surprisingly, the IRS understands that sometimes the beneficiary hasn’t had time to determine whether or not to disclaim. As a result, the IRS allows the RMD for the year of death to be distributed to the beneficiary but not counted as a benefit when disclaiming.
Disclaiming traps
I do want to mention a few possible pitfalls of disclaiming. A few of these have been touched on, but I want to stress some possible problems:
- Bankruptcy: A few states want to ensure you’re not disclaiming while filing for bankruptcy and require a statement attesting to that fact.
- Medicaid: If you’re trying to qualify for Medicaid, for example, some states consider a disclaimed inheritance as a recently transferred asset, which could affect your eligibility for the program.
- Veterans benefits and Supplemental Security Income: The VA may not look kindly to disclaiming while receiving benefits.
I cannot stress enough the need to consult with an attorney and CERTIFIED FINANCIAL PLANNER™ professional to determine the legality and financial benefits of disclaiming assets.
Disclaiming an inheritance is a little-known strategy that can be used to achieve your financial and tax goals. However, planning and thought must go into the decision, along with understanding the ramifications for you and the next beneficiaries in line. Tread carefully and seek professional advice.
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