Well, I’m going to give you my take on this, but you are making some wrong assumptions — so before making any decisions, please consult an estate planning attorney in your state.
As I read this, your question revolves entirely on mutual funds held OUTSIDE a qualified retirement plan.
So, your Case 1 is partly correct –under current law. The surviving spouse gets a step-up in value (value as of the date of death) for the portion that belonged to the deceased. BUT, the surviving spouse must then either re-title the account in his own name, or preferably a revocable living trust to distribute the fund shares upon HIS death. Or, perhaps, title the survivor’s account in joint name with the children — but that could expose the asset to claims in case of a divorce or lawsuit on the part of an adult child. So renaming the account after death is an important consideration. But yes, the heirs would get a step-up in cost basis to the value of the account on the date of death.
Now, as to your second case, stocks or mutual funds held individually — and outside a qualified retirement plan –DO NOT HAVE A BENEFICIARY! At your death, the value of the account would be distributed to your heirs, who would receive the account on a step-up basis. But if you leave the share via a will, it must go through probate –and the distribution could be delayed, which could be costly. If your brokerage account is re-named in the name of your Revocable Living Trust, then your named successor trustee can distribute the proceeds to your named heirs as soon as the death certificate and appropriate trust resolutions are presented to the brokerage firm — without the time-consuming and public process of probate.
So if you’re worried about what happens after your death, please do consult an estate planning attorney. There are more pitfalls here than just tax considerations.