Specialized Returns for Individuals · Estate tax

Life insurance, IRAs and retirement plans

Verification 2026 Verified
tax year · reviewed 2026-08-20 · Draft for I. Ohu review

Two of the largest assets in an ordinary estate are treated in almost opposite ways, and clients assume they are the same because both pass by beneficiary designation outside the will. Life insurance is generally in the gross estate and generally free of income tax. A traditional retirement account is in the gross estate and fully taxable as income to whoever receives it, with no basis adjustment to soften it. A policy and a retirement account of the same face amount are not equivalent bequests, and telling a client which child gets which is a real decision.

The rule

Insurance: in the estate. insurance on the decedent's life is in the gross estate to the extent receivable by the executor, and to the extent receivable by anyone else where the decedent possessed any incident of ownership at death, exercisable alone or with another (IRC § 2042)^TY2026 Incident of ownership is the operative phrase and it is broader than title — the right to change the beneficiary, to surrender, to borrow against the policy, or to assign it will each do.

Insurance: out of income. proceeds under a life insurance contract paid by reason of the death of the insured are excluded from gross income, subject to the transfer for value rule and the other exceptions in IRC § 101(a)(2), (d), (f) and (j)^TY2026

And the transfer that came too late. property transferred, or a power relinquished, within the 3-year period ending at death is pulled back into the gross estate where it would have been included under IRC § 2036, 2037, 2038 or 2042 had the interest or power been retained (IRC § 2035(a))^TY2026 Giving a policy away works only if the donor survives three years.

Annuities have their own section. the gross estate includes an annuity or other payment receivable by a beneficiary by reason of surviving the decedent under any contract other than life insurance, where an annuity or payment was payable to the decedent, or the decedent had the right to receive one, for life or for a period not ascertainable without reference to death or not in fact ending before death (IRC § 2039(a))^TY2026 Section 2039 catches the survivorship feature of a joint and survivor annuity, and it expressly does not cover life insurance, which § 2042 handles instead.

Retirement accounts: in the estate, and taxable. A retirement account is in the gross estate as property the decedent had an interest in, and it is also items of gross income of a decedent not properly includible in the period ending with death are taxed to whoever receives them — the estate, the person acquiring the right by reason of the death, or a person receiving it by bequest, devise or inheritance from the decedent (IRC § 691(a)(1))^TY2026 That is the crucial difference: the beneficiary receives the account and the income tax liability together.

With no basis relief. income in respect of a decedent takes no fair market value basis — IRC § 1014(c) excepts it from the general rule, so a traditional IRA passes to a beneficiary with its income tax charge intact^TY2026

But with one offset. a deduction for the estate tax attributable to the item, in the same ratio that the item's estate tax value bears to the estate tax value of all such items — so the same dollars are not taxed twice without relief (IRC § 691(c)(1))^TY2026

And a distribution clock. 10 years — for a defined contribution plan, the whole interest must be distributed within 10 years of the employee's death, whether or not distributions had begun, except for an eligible designated beneficiary (IRC § 401(a)(9)(H)(i))^TY2026 The exception is narrow: five categories, tested as of the date of the employee's death — the surviving spouse, a child of the employee who has not reached majority, a disabled individual within IRC § 72(m)(7), a chronically ill individual within § 7702B(c)(2) with a certification of indefinite and lengthy inability, and any individual not more than 10 years younger than the employee (IRC § 401(a)(9)(E)(ii))^TY2026 Two rules close it off over time: a minor child ceases to be an eligible designated beneficiary on reaching majority, and the remainder must then be distributed within 10 years of that date (IRC § 401(a)(9)(E)(iii))^TY2026 when an eligible designated beneficiary dies before the interest is fully distributed, the exception stops — the beneficiary's own beneficiary gets 10 years from that death and nothing longer (IRC § 401(a)(9)(H)(iii))^TY2026

Current figures

Item	Rule
Insurance in the gross estate	insurance on the decedent's life is in the gross estate to the extent receivable by the executor, and to the extent receivable by anyone else where the decedent possessed any incident of ownership at death, exercisable alone or with another (IRC § 2042)^TY2026
Insurance excluded from income	proceeds under a life insurance contract paid by reason of the death of the insured are excluded from gross income, subject to the transfer for value rule and the other exceptions in IRC § 101(a)(2), (d), (f) and (j)^TY2026
Three-year rule on transferred policies	property transferred, or a power relinquished, within the 3-year period ending at death is pulled back into the gross estate where it would have been included under IRC § 2036, 2037, 2038 or 2042 had the interest or power been retained (IRC § 2035(a))^TY2026
Annuities	the gross estate includes an annuity or other payment receivable by a beneficiary by reason of surviving the decedent under any contract other than life insurance, where an annuity or payment was payable to the decedent, or the decedent had the right to receive one, for life or for a period not ascertainable without reference to death or not in fact ending before death (IRC § 2039(a))^TY2026
Income in respect of a decedent	items of gross income of a decedent not properly includible in the period ending with death are taxed to whoever receives them — the estate, the person acquiring the right by reason of the death, or a person receiving it by bequest, devise or inheritance from the decedent (IRC § 691(a)(1))^TY2026
No basis step-up	income in respect of a decedent takes no fair market value basis — IRC § 1014(c) excepts it from the general rule, so a traditional IRA passes to a beneficiary with its income tax charge intact^TY2026
Estate tax deduction	a deduction for the estate tax attributable to the item, in the same ratio that the item's estate tax value bears to the estate tax value of all such items — so the same dollars are not taxed twice without relief (IRC § 691(c)(1))^TY2026
Ten-year distribution rule	10 years — for a defined contribution plan, the whole interest must be distributed within 10 years of the employee's death, whether or not distributions had begun, except for an eligible designated beneficiary (IRC § 401(a)(9)(H)(i))^TY2026
Eligible designated beneficiary	five categories, tested as of the date of the employee's death — the surviving spouse, a child of the employee who has not reached majority, a disabled individual within IRC § 72(m)(7), a chronically ill individual within § 7702B(c)(2) with a certification of indefinite and lengthy inability, and any individual not more than 10 years younger than the employee (IRC § 401(a)(9)(E)(ii))^TY2026
Minor child on reaching majority	a minor child ceases to be an eligible designated beneficiary on reaching majority, and the remainder must then be distributed within 10 years of that date (IRC § 401(a)(9)(E)(iii))^TY2026
Death of an eligible designated beneficiary	when an eligible designated beneficiary dies before the interest is fully distributed, the exception stops — the beneficiary's own beneficiary gets 10 years from that death and nothing longer (IRC § 401(a)(9)(H)(iii))^TY2026
Basic exclusion amount	$15,000,000 for a decedent dying in calendar year 2026 — the IRC § 2010(c)(3)(A) basic exclusion amount as raised by Pub. L. 119-21 § 70106, indexed from calendar year 2026 and rounded to the nearest $10,000 under § 2010(c)(3)(B)^TY2026
Basis contrast	property acquired from a decedent takes a fair market value basis at death under IRC § 1014(a); property acquired by gift takes the donor's basis under § 1015(a), with a special rule using fair market value where that is lower and the sale produces a loss^TY2026

How it works in practice

Price the two assets net, not gross. An heir receiving a policy receives its face amount. An heir receiving a traditional IRA of the same size receives that amount less the income tax on it, at that heir’s own rates, spread over at most ten years. Where a will divides an estate “equally” between children and one takes the IRA, the division is not equal.

Which is why the charity should get the IRA. A charitable beneficiary pays no income tax on income in respect of a decedent, so naming a charity on the retirement account and leaving other assets to individuals produces the same gift at a lower total cost. This is the single most reliable piece of advice in the topic.

Check who owns the policy, not who is insured. Section 2042(2) turns on incidents of ownership at death. A policy the decedent’s employer owns, or an irrevocable trust owns and has owned for more than three years, is outside the estate. A policy the decedent owned on their own life is inside it, however the proceeds are payable.

Do not confuse the two exclusions. The § 101(a) exclusion is from income tax. It says nothing about the estate tax, and clients routinely take “life insurance isn’t taxable” to mean the proceeds are outside the estate. Under a large exclusion amount that misunderstanding is usually harmless, and in the estates where it matters it is expensive.

Claim the § 691(c) deduction. Where estate tax was actually paid on an account, the beneficiary gets an income tax deduction for the estate tax attributable to the item as it is drawn down. It is frequently missed because the beneficiary receiving the Form 1099-R has no visibility of the estate tax return.

Model the ten years. The rule requires the account emptied within ten years; it does not require anything in years one to nine for most beneficiaries. Where a beneficiary expects a low-income year — a sabbatical, a year between jobs, retirement — timing withdrawals into it is worth real money, and it is the only planning left once the account has passed.

The equal division that was not

A widow leaves a $600,000 traditional IRA to her son and a $600,000 brokerage account to her daughter, believing she has divided things evenly. The brokerage account holds long-held shares with a basis of $180,000.

The daughter receives $600,000 with a fresh basis at death under IRC § 1014, so she can sell immediately at no gain. The son receives $600,000 of income in respect of a decedent: every dollar he withdraws is ordinary income, § 1014(c) denies him any basis adjustment, and the whole account must be emptied within ten years. At a 32 percent marginal rate his bequest is worth around $408,000 against his sister’s $600,000. The estate tax result is identical for both; the income tax result is not.

The policy in the trust, and the one that was not

A man sets up an irrevocable life insurance trust which applies for and buys a new $2,000,000 policy on his life. He also assigns an older $500,000 policy he already owned to the same trust. He dies twenty months later.

The $2,000,000 is outside his estate — the trust applied for and always owned it, so he never held an incident of ownership. The $500,000 is inside it, because § 2035(a) reaches the assignment made within three years of death of property that would have been included under § 2042. Same trust, same trustee, same intention, two different answers, and the difference is whether the policy was ever his.

The charity that cost nothing extra

A woman wants to leave $200,000 to a hospital and the rest to her nephew. Her assets are a $200,000 traditional IRA and a $700,000 house.

If she leaves the house to the hospital and the IRA to her nephew, the nephew pays income tax on the whole $200,000 as he draws it. If she names the hospital as beneficiary of the IRA and leaves the house to the nephew, the hospital receives $200,000 and pays nothing, and the nephew takes a house with a date-of-death basis. The charity is indifferent between the two; the nephew is roughly $60,000 better off under the second.

The exception that expired twice

A man dies leaving his IRA to his daughter, who is fourteen. She is an eligible designated beneficiary as a minor child of the employee, so she may take distributions over her life expectancy rather than within ten years.

That lasts until she reaches the age of majority. From that date IRC § 401(a)(9)(E)(iii) requires the remainder to be distributed within ten years, so the stretch runs for a few years and then converts to a deadline. Had the beneficiary instead been the decedent’s disabled brother, the life expectancy method would have run for his life — but on his death, § 401(a)(9)(H)(iii) would give his beneficiary ten years and nothing more. The exception never passes to a second generation.

Thinking life insurance proceeds are outside the gross estate. IRC § 101(a) excludes them from income, not from the estate. Section 2042 puts them in wherever the decedent held an incident of ownership.

Reading “incident of ownership” as title. The right to change the beneficiary, borrow against the policy, surrender it or assign it are each incidents of ownership, and any one is enough.

Assuming a transfer to a trust removes a policy immediately. Only if the donor survives three years (IRC § 2035(a)). A trust that applies for and buys the policy itself never has the problem.

Treating an inherited IRA as inheriting money. It carries the income tax charge with it. Section 1014(c) denies the fair market value basis that other inherited property receives.

Forgetting the § 691(c) deduction where estate tax was paid. The beneficiary is entitled to it, and the information needed to compute it lives on a return the beneficiary usually never sees.

Applying § 2039 to life insurance. Section 2039(a) expressly excludes insurance on the decedent’s life; that is § 2042’s territory. Section 2039 is for annuities and other survivor payments.

Reading the ten-year rule as requiring annual distributions for everyone. It requires the account emptied by the end of year ten. Where the account owner had already begun required distributions, annual amounts continue during that period as well — but for most beneficiaries the flexibility inside the ten years is real and worth using.

How this has changed

Section 401(a)(9)(H) is the recent part and it changed the topic completely. Until it was added, a designated beneficiary could generally take distributions over their own life expectancy — the “stretch” that supported a great deal of planning. That is now confined to the five eligible designated beneficiary categories, everyone else has ten years, and even an eligible designated beneficiary’s own beneficiary gets ten years and no more. The practical consequence is that a retirement account is no longer a multi-generational vehicle, and advice that treats it as one is obsolete.

Sections 101, 691, 1014(c), 2035, 2039 and 2042 have not changed in substance in decades, and Pub. L. 119-21 amended none of them. What the 2025 Act changed is the surrounding pressure: with the basic exclusion amount at $15,000,000 for a decedent dying in calendar year 2026 — the IRC § 2010(c)(3)(A) basic exclusion amount as raised by Pub. L. 119-21 § 70106, indexed from calendar year 2026 and rounded to the nearest $10,000 under § 2010(c)(3)(B)^TY2026 and permanent, very few of these estates will pay estate tax at all. That makes the § 691(c) deduction irrelevant for most clients — there is no estate tax to deduct — and moves the entire topic onto the income tax side, where the ten-year rule and the absence of a basis step-up are the only things that matter.

It also sharpens the insurance point. The reason to worry about incidents of ownership was estate inclusion, and for most estates that has ceased to matter. What has not ceased to matter is that insurance proceeds arrive income-tax free while retirement accounts do not, which is now the dominant consideration in deciding which asset goes to whom.

Exam focus

The reliable question is the § 2042 incidents of ownership test — expect a decedent who transferred a policy and a date that is inside or outside three years.

Know that § 101(a) is an income tax exclusion and § 2042 an estate tax inclusion, and that both can apply to the same proceeds. Know that § 2039 covers annuities and expressly not life insurance.

On the retirement side, know that an inherited traditional account is income in respect of a decedent under § 691(a) with no step-up under § 1014(c), that the § 691(c) deduction exists, and that the general rule is ten years with five categories of eligible designated beneficiary. The minor child rule is the one most often got wrong: the exception ends at majority and ten years run from there.

Check yourself

1. A decedent’s employer owned and paid for a policy on his life, payable to his widow. He held no rights under it. Is it in his gross estate?

Answer: No. IRC § 2042(2) includes proceeds receivable by other beneficiaries only where the decedent possessed an incident of ownership at death, and § 2042(1) reaches only amounts receivable by the executor. He held neither.

2. A taxpayer inherits her father’s traditional IRA. What is her basis in it?

Answer: She has no stepped-up basis. The account is income in respect of a decedent, and IRC § 1014(c) excepts such property from the fair market value basis rule, so distributions are ordinary income under § 691(a).

3. A decedent assigned a policy on his own life to his brother 40 months before dying. Are the proceeds in his gross estate?

Answer: No. IRC § 2035(a) reaches transfers within the 3-year period ending at death; 40 months is outside it, and he held no incident of ownership at death for § 2042 to reach.

4. Who qualifies as an eligible designated beneficiary?

Answer: Under IRC § 401(a)(9)(E)(ii), the surviving spouse, a child of the employee who has not reached majority, a disabled individual, a chronically ill individual, or an individual not more than 10 years younger than the employee — tested as of the date of the employee’s death.

5. A grandson inherits a defined contribution account from his grandmother, who died at 80. Over what period must he take it?

Answer: Within 10 years of her death. He is a designated beneficiary but not an eligible designated beneficiary, so IRC § 401(a)(9)(H)(i) applies, whether or not she had begun taking distributions.

Change log

2026-08-20Initial draft. Contrasts life insurance — in the gross estate under IRC § 2042 but excluded from income under § 101(a) — with retirement accounts, which are in the gross estate and are also income in respect of a decedent under § 691(a) with no basis step-up under § 1014(c). Covers annuities under § 2039, the § 2035(a) three-year rule on transferred policies, the § 691(c) estate tax deduction, and the ten-year distribution rule and eligible designated beneficiary categories in § 401(a)(9)(E) and (H).