What is the most overlooked area in estate planning today in terms of how you pass your assets to your loved ones – your family, your kids, your grandkids – and even to causes that are important to you – your church and charities? In my opinion, it is how we transition our retirement accounts.

Remember, you’ve never paid any income tax on most or if not all of that money. Any distribution after the date of death is taxed to the beneficiaries. According to the IRS, over 90 percent of all IRAs are cashed in at the death of the second spouse.

If you have a couple hundred thousand dollars in your IRA or 401k, and it goes to your child and they cash it in, they’re actually going to have to report $200,000 on his or her income tax in the same year on the IRA distribution line. That money is going to be added into all of the ordinary income and result in a very high tax rate.

It’s an income tax time bomb that more often than not goes off at death. So how do you diffuse that time bomb? Starting the year after your death, your kids don’t have to cash it in. Starting the next year, they do have to start taking a little bit of money out each year based on their own age.

For example, if your child is 50 and his life expectancy is estimated to be 33 years, the first year he would have to take out 1/33 of the account, or 3 percent. The next year, he would take out 1/32, then 1/31, 1/30, etc. He can always take more, but he has to take the minimum. What your child is doing is stretching that retirement account across the rest of his life, or put another way, he stretches that tax burden. We call that a stretch IRA.

To help your kids and grandkids have control over this money and have the tools to diffuse the income tax time bomb, in my opinion, you need customized beneficiary instructions that make absolutely certain they’re going to be able to stretch these benefits or do whatever they want and have the flexibility to do it.

I have published an IRA Beneficiary Checklist that refers to the need to potentially have a customized form. Check it out HERE.