Inheriting money can provide a windfall, but the last thing you want is to discover that it comes with a hefty tax bill
In the movies, an inheritance is (almost) always a good thing — an often-unexpected financial windfall with few, if any, strings attached. (Well, unless it’s a movie about a jealous, possibly even murderous, family fighting over said inheritance. But we’ll assume your life is not like that.)
One thing that rarely comes up in those movies: Is inherited money taxable? In real life, the answer is: It depends.
Generally speaking, inherited money itself is not considered taxable income for federal tax purposes. However, certain factors might make the funds a tax liability, including state laws and the size of the estate.
By understanding the ins and outs of these tax implications, you can better plan for any potential taxes owed on inherited money.
In this article:
How inherited money works
When it comes to inherited money, there’s a lot more to it than just receiving a lump sum of cash.
A person receives an inheritance when a deceased person leaves them money, property, or investments. The recipient might be the named beneficiary in the decedent’s will or trust, or be legally entitled to receive the assets under state law if there is no valid will or trust.
When it comes to taxes, the Internal Revenue Service (IRS) defines inheritance as a transfer of money, property, and other assets from a deceased person to their heirs. Inherited money is not taxable income for the recipient. However, certain inherited assets might be subject to taxes.
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When is inherited money taxable?
In general, inherited money is not considered taxable income for the beneficiary. You do not need to report the inheritance as income on your tax return. However, there are specific situations in which taxes might come into play.
Estate taxes are imposed on the estate of a deceased person, and the estate pays them before assets are distributed to the beneficiaries. If the estate’s value is very high — as of 2023, the federal estate tax ranges from rates of 18% to 40%, and generally only applies to assets over $12.92 million — estate taxes might apply.
In addition, according to the Tax Foundation, twelve states and Washington, D.C., have an estate tax; six states have an inheritance tax, with Maryland having both. It’s essential to consult with a qualified estate planning attorney or tax professional to understand which estate tax laws might apply to you.
Inherited retirement accounts
Inherited retirement accounts, such as traditional IRAs or 401(k)s, are subject to taxation. When you receive distributions from an inherited retirement account, they are typically treated as ordinary income and subject to income tax.
Required minimum distribution (RMD) rules are regulations that require the beneficiary to take out a certain amount from the account each year. An estate planning expert can help you implement tax-efficient strategies for managing inherited retirement accounts.
Capital gains tax
Inherited assets such as stocks, real estate, or other investments might be subject to capital gains tax if the beneficiary sells them. The tax is calculated based on the difference between the fair market value of the inherited asset at the time of the original owner’s death and the selling price.
When is inherited money not taxable?
Now that you know when inherited money might be subject to taxation, let’s look at some scenarios when it’s not.
Gifts and bequests
When a person passes away, they can leave cash gifts or bequests to their heirs without any tax implications for the beneficiary. These gifts are generally not considered taxable income for the recipient. However, the IRS limits the amount of money a person can give away without being subject to gift taxes. In 2023, the gift limit is $17,000 per person.
Roth IRAs and other tax-advantaged accounts
The funds are typically not taxed when you inherit a Roth IRA or other tax-advantaged accounts. This is because these accounts have already been subject to taxes.
Life insurance proceeds
Generally, life insurance benefits are not considered taxable income for the beneficiary. The beneficiary named in the policy will receive the funds tax-free. The insurer should send a 1099-R form with the insurance proceeds, but this document is only used for informational purposes. It does not need to be reported as income for tax purposes.
There are some rare exceptions in unusual cases. The IRS website provides detailed information on how life insurance proceeds are taxed.
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How to plan ahead
So how can you do right by your potential heirs? While estate planning can feel overwhelming, it helps ensure your loved ones are cared for after you’re gone. Writing a will, for example, lets you outline your wishes explicitly. A will can also help prevent confusion or disagreements among your loved ones about how your assets will be distributed.
And to clear up a common misperception: Even if you don’t consider yourself wealthy, a will is an essential tool to ensure your loved ones receive your assets, whatever those assets are. (Pro tip: Eligible Haven Term policyholders enjoy no-cost will services from Trust & Will through the Haven Life Plus bonus rider.)
But the estate planning process shouldn’t end with drafting a will. A power of attorney and trust are also options you might want to consider.
A power of attorney allows you to name someone who can make decisions on your behalf if you become ill or incapacitated. A trust is an arrangement that allows a third party to hold and manage assets for the benefit of another person. Trusts can also help protect your assets from taxes. You might also want to consult with a financial advisor or tax attorney to ensure that all your taxes and other obligations are properly taken care of.
Before distributing your assets, the court will review your will to ensure its validity during the probate process. An executor or administrator will be appointed to manage the estate’s assets and debts. You can specify who serves as the executor in your will, but if you don’t, the court will appoint someone to manage your estate.
Any taxes due must be paid out of the estate for funds to be dispersed. The executor then distributes the remaining funds to beneficiaries, and it’s up to them to decide how best to use the money.
Speaking of planning ahead…
One other essential tool for long-term financial planning? Life insurance. Life insurance is a form of financial protection for your loved ones in case the worst should happen to you. If you have people who depend on you to pay for things — from groceries to housing to tuition — you should strongly consider a life insurance policy that will provide much-needed money in case you die.
Haven Life offers term life insurance, an affordable type of life insurance that provides coverage during the years when you’re earning a salary and responsible for others’ financial well-being. Find out more by getting a free online life insurance quote today.
Our editorial policy
Haven Life is a customer-centric life insurance agency that’s backed and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe navigating decisions about life insurance, your personal finances and overall wellness can be refreshingly simple.
Our editorial policy
Haven Life is a customer centric life insurance agency that’s backed and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe navigating decisions about life insurance, your personal finances and overall wellness can be refreshingly simple.
Our content is created for educational purposes only. Haven Life does not endorse the companies, products, services or strategies discussed here, but we hope they can make your life a little less hard if they are a fit for your situation.
Haven Life is not authorized to give tax, legal or investment advice. This material is not intended to provide, and should not be relied on for tax, legal, or investment advice. Individuals are encouraged to seed advice from their own tax or legal counsel.
Haven Term is a Term Life Insurance Policy (DTC and ICC17DTC in certain states, including NC) issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001 and offered exclusively through Haven Life Insurance Agency, LLC. In NY, Haven Term is DTC-NY 1017. In CA, Haven Term is DTC-CA 042017. Haven Term Simplified is a Simplified Issue Term Life Insurance Policy (ICC19PCM-SI 0819 in certain states, including NC) issued by the C.M. Life Insurance Company, Enfield, CT 06082. Policy and rider form numbers and features may vary by state and may not be available in all states. Our Agency license number in California is OK71922 and in Arkansas 100139527.
MassMutual is rated by A.M. Best Company as A++ (Superior; Top category of 15). The rating is as of Aril 1, 2020 and is subject to change. MassMutual has received different ratings from other rating agencies.
Haven Life Plus (Plus) is the marketing name for the Plus rider, which is included as part of the Haven Term policy and offers access to additional services and benefits at no cost or at a discount. The rider is not available in every state and is subject to change at any time. Neither Haven Life nor MassMutual are responsible for the provision of the benefits and services made accessible under the Plus Rider, which are provided by third party vendors (partners). For more information about Haven Life Plus, please visit: https://havenlife.com/plus
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