Tax Treatment of Different Account Types: Why It Matters in Life and Legacy
“In this world nothing can be said to be certain, except death and taxes.” — Benjamin Franklin
Franklin’s words still ring true today, especially when it comes to building wealth and planning for the future. While we can’t avoid either grisly topic, we can plan for them—and with the right strategy, we can minimize the burden of both on our loved ones.
One of the most overlooked ways to reduce lifetime taxes and improve the efficiency of your legacy is understanding how different types of investment and savings accounts are taxed—both during your life and after you’re gone. The type of account you use—whether a retirement plan, brokerage account, education fund, or custodial account—can have a major impact on how much tax you’ll pay and how much of your wealth your loved ones will ultimately receive.
Let’s take a closer look at the tax treatment of the most common account types, and then discuss why tying everything together through a coordinated financial and estate plan is key to building and preserving wealth.
1. Taxable Brokerage Accounts: Flexibility with Ongoing Tax Considerations
Taxable accounts—owned individually, jointly, or through a revocable trust—offer a high degree of flexibility. You can buy, sell, or withdraw at any time, which provides great flexibility and liquidity for any investor. However, that flexibility comes with ongoing tax consequences.
During Life:
• You’ll pay taxes each year on interest, dividends, and realized capital gains.
• Qualified dividends (from most U.S. stocks held for a minimum period) and long-term capital gains (profits on investments held more than a year) are taxed at preferential rates (0%, 15%, or 20%, depending on your income).
• Short-term capital gains (profits on investments held less than an year) and non-qualified dividends are taxed at ordinary income rates (which range from 10-27%, depending on your income).
• A taxable brokerage account gives you the flexibility to offset capital gains with capital losses, which can significantly reduce your tax bill. Unlike traditional retirement accounts, it allows you to actively manage when gains and losses are realized—making it a valuable tool for ongoing tax efficiency.
At Death:
• One of the most powerful features of taxable brokerage accounts is the step-up in cost basis at death. When assets are passed to heirs, their cost basis is adjusted to the fair market value as of your passing, not at what you originally paid. The result? Years—or even decades—of capital gains can potentially disappear for tax purposes, giving your beneficiaries a cleaner, more tax-efficient start.This makes taxable accounts powerful tools for long-term investing and estate planning. This is especially true when you have low-basis assets that have appreciated significantly since you purchased them.
2. Traditional Retirement Accounts (401(k)s, 403(b)s, and IRAs): Tax-Deferred
Today, Taxed Tomorrow
Traditional IRAs and employer-sponsored plans like 401(k)s or 403(b)s offer valuable tax deferral during your working years, but eventually, Uncle Sam gets his cut.
During Life:
• Contributions may be tax-deductible, and growth inside the account is tax-deferred.
• Withdrawals in retirement are taxed at ordinary income rates, which, theoretically, should be at a lower rate in retirement as opposed to when you are actively working.
• After age 73 (or 75 for some, depending on your birth year), the government requires you to take distributions from the account (Required Minimum Distributions (RMDs)).
At Death:
• Beneficiaries do not receive a step-up in basis. Instead, they inherit the account with its full tax liability and pay taxes at their regular income tax rate (not the original deceased account owner).
• Non-spouse beneficiaries are generally required to withdraw the entire account within 10 years starting the year after you died. This can create significant income tax consequences for the unsuspecting.
• Spouses have more flexibility and can often roll the account into their own IRA or take distributions over their lifetime expectancy. While traditional retirement accounts are great for accumulating tax-deferred savings, they require strategic planning later in life and at death to avoid unnecessary tax burdens.
3. Roth IRAs and Roth 401(k)s: Tax-Free Growth and Withdrawals
Roth accounts flip the traditional model on its head: you pay taxes on the money before it goes in, and qualified withdrawals are completely tax-free (Thank you, Senator William V. Roth, Jr., for this gift).
During Life:
• Contributions are made with after-tax dollars and investment earnings grow tax-free.
• Qualified withdrawals are not taxed.
• Roth IRAs have no RMD requirements during your lifetime, offering flexibility and preserving the account’s tax-free status for as long as possible.
At Death:
• Heirs inherit Roth accounts income tax-free as well, though the 10-year withdrawal rule discusses above still applies for most non-spouse beneficiaries. Roth accounts are powerful tools for tax diversification and estate planning—especially if you expect to be in a higher tax bracket later in life or want to minimize taxes for your beneficiaries.
4. 529 College Savings Plans: Tax Benefits for Education (and More)
529 plans, or Qualified Tuition Programs, are designed to help families save for education, offering a mix of federal and state tax benefits.
During Life:
• Contributions are made with after-tax dollars, but investment earnings grow tax-free.
• Withdrawals are tax-free when used for qualified education expenses (tuition, fees, books, supplies, etc.).
At Death:
• 529 plan assets are generally considered part of the account owner’s estate and could be subject to federal estate taxes depending on the size of the account owner’s estate.
• However, the IRS allows you to “front-load” up to five years of annual gift exclusions ($90,000 per beneficiary in 2025 for individuals, or $180,000 for married couples), helping reduce your taxable estate efficiently. The account owner can retain control even after making the gift—a rare advantage in estate planning.
• If the plan has a designated successor owner, the account control passes to the successor without disruption. Even beyond education, 529 plans now allow limited use for student loan repayment and can potentially be rolled into a Roth IRA for the beneficiary (subject to strict conditions), adding even more flexibility.
5. UTMA/UGMA Custodial Accounts: Gifts to Minors with Limited Control
These accounts are created under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) and are used to transfer assets to children while retaining adult control until they reach the age of majority.
During Life:
• Income generated in the account is taxed to the child, subject to the "kiddie tax.”
• The first $1,350 of unearned income (interest, dividences, and capital gains) is tax-free.
• The next $1,350 is taxed at the child’s rate.
• Income above $2,700 (in 2025) is taxed at the parents' rate.At Death:
• Because the assets legally belong to the child, they are not included in the donor’s estate.
• There is no step-up in basis, and the child gains full control of the account once they reach the age of majority (usually 18 or 21, depending on the state). These accounts are useful for minor gifts but come with limitations on control and tax efficiency.
Why Coordination Matters: Financial and Estate Planning as a Team Effort
As you can see, every account—whether it’s a 401(k), IRA, Roth, or brokerage—comes with its own tax rules, but none of them operate in isolation. Building lasting wealth means tying it all together with a smart financial plan and an estate strategy that supports your long-term goals.
A strong financial plan ensures you're using the right accounts for the right goals, investing tax-efficiently, managing withdrawals wisely in retirement, and making the most of strategies like Roth conversions, charitable giving, and tax-loss harvesting.
At the same time, a thoughtful estate plan ensures your assets pass smoothly and tax-efficiently to your heirs. It clarifies your wishes, helps avoid probate delays, and uses tools like trusts, beneficiary designations, and gifting strategies to potentially reduce taxes. When financial and estate planning work hand in hand, they create a clear, efficient roadmap that protects your wealth both during your lifetime and for generations to come.
Final Thoughts
Tax treatment may not be the most exciting part of your financial life, but it is one of the most important. Knowing how your accounts are taxed—and planning accordingly—can help you reduce your tax burden, keep more of your wealth, and leave a stronger legacy.
If you’re unsure whether your accounts are structured in the most tax-efficient way, let’s talk. A well-integrated plan doesn’t just look at today—it’s designed to carry you and your loved ones confidently into the future.
Disclosure:
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA.
In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.