Question:
❓ You’ve spent your life building money in four places (a traditional 401(k), a Roth IRA, a taxable brokerage account, and a life insurance payout), and you want to leave your kids the most after-tax money. Which one hands them the biggest tax bill?
A) The Roth IRA
B) The traditional 401(k)
C) The brokerage account
D) A life insurance payout
✅ Answer: B)
The traditional 401(k)
Here’s why:
An inherited traditional 401(k) (or traditional IRA) hands your kids the biggest tax bill because every dollar that comes out is taxed as ordinary income. That money was funded pretax and never taxed going in, so the IRS collects on the way out instead. When a non-spouse adult child inherits one, a 10-year rule forces them to empty the whole account within 10 years.
That window often lands right in their peak earning years, stacking on top of their own salary and pushing them into higher brackets. So if you’ve ever wondered whether your kids pay taxes on an inherited 401(k), the answer is yes, at their regular income rate, on every withdrawal. (Your state may add its own income tax on top of that.)
The same $500,000 reaches your kids very differently depending on which account it sat in:
| Leave $500,000 in… | Federal income tax your kids owe | What reaches them |
|---|---|---|
| A traditional 401(k) | ~$120,000 (taxed as ordinary income)* | ~$380,000 |
| A Roth IRA | $0 | $500,000 |
| A taxable brokerage account | ~$0 (step-up in basis) | ~$500,000 |
| A life insurance payout | $0 | $500,000 |
*Assumes your child withdraws the 401(k) while in the 24% federal bracket; a higher earner or a faster drawdown owes more. The other three reach your kids with little or no income tax.
Why the others are not correct:
A) Yes, your kids still have to empty it within 10 years, and that 10-year deadline is what trips up the guess here. But qualified withdrawals from an inherited Roth come out income-tax-free, because you already paid the tax going in. Same clock, none of the sting.
C) "Selling stock" sounds like a giant capital gains hit, which is exactly why this one is the trickiest of the four. But a brokerage account gets a step-up in basis at death. Your kids’ cost basis resets to the value on the day you pass, so a lifetime of gains simply disappears for tax purposes. They could sell the next morning and owe little or nothing. It’s actually one of the most tax-friendly accounts to leave behind.
D) A six-figure check landing all at once can feel like it should come with a tax bill attached. It generally doesn’t. A life insurance death benefit is income-tax-free to your beneficiaries, so your kids receive the full amount and owe no income tax on it. That keeps it well clear of the biggest tax bill.
Takeaway:
If you want the most tax-efficient money to leave to your children, the pretax 401(k) is the one to spend down or convert in your lifetime, and the Roth, the brokerage account, and life insurance are the ones to hold. Most people build all of this without ever asking which piece costs their kids the most to inherit.
Inside the TWC Network, you can work with a financial professional to map out which accounts to draw down, which to convert to Roth, and which to leave untouched, so more of what you built reaches your kids instead of the IRS.
→ Learn with us inside the TWC Network
Sources:
IRS Publication 590-B (inherited IRA distributions)
IRS Publication 551 (basis of assets / step-up)
IRS — Life insurance & disability insurance proceeds
