“Taxes on death”: do I have to pay taxes when I inherit money? Strategy for 401 (k) s and IRAs on Inheritance
You have just received an inheritance. What are you doing right now? You could spend it wildly, but you’d better do two things first: assess the tax ramifications and think about some investment options.
“Death taxes” are somewhat misunderstood, as people may find the two types of death taxes confused. Inheritance tax applies at the start of the estate transfer process and is subtracted from the overall value of the estate. They only apply to huge estates and reduce the size of your inheritance in advance; you no longer have a tax obligation. The Tax Cuts and Jobs Act (TCJA) increased the lifetime inheritance tax exemption to $ 11.58 million for single filers and $ 23.16 million for married couples declaring jointly in the 2020 tax year.
Inheritance tax, when it exists, applies to beneficiaries. There is no federal inheritance tax, and only six states impose inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
State inheritance tax depends on income as well as the relationship of the heir to the deceased. Taxes are applied on a sliding scale of one to eighteen percent. Even if it applies to the beneficiary of the inheritance, the tax is applied according to the place of residence of the deceased. So you need to check state laws to see if you owe state inheritance taxes.
Income tax does not apply to cash or inherited assets, but non-cash assets will be subject to tax whenever they are sold. The base of the property sold is increased by the value at the time of death, that is to say that if you inherit the house from your parents and sell it one year later, the gain or loss that affects your tax is based on it. year of value change. Otherwise, you would be forced to pay capital gains on the change in value between the date of sale and when your parents bought the house, adding thousands to your tax bill.
The rules are slightly different among different non-monetary assets. For savings bonds, the only taxes you will have to pay are on the interest accrued during the life of the deceased (assuming that the declaration of interest has been deferred until repayment). Inherited annuities accumulate taxes at the regular tax rate, but the exact amount and time of payment depends on the type of annuity (employer or private), the terms of the annuity, and the start of distributions. The annuity issuer will have the relevant details.
The strategy for inherited retirement accounts (401 (k) s and IRAs) depends on your relationship with the deceased and your respective ages.
- You and your deceased spouse are over 70 and a half – Minimum distributions have already started. You can leave it as is and receive the distributions, build them into a Legacy IRA, or build them into your own spousal IRA – usually the least painful choice for the next generation after your death. Since January 1, 2020, the minimum age for starting distributions has been raised to 72 years.
- You are a spouse aged 59 ½ to 70 and a half – The same options apply, but the spouse option is even better, since you can defer distributions until age 70 and a half (72 from 2020 ).
- You are a spouse under 59 and a half – In this case, the situation is reversed. Early distributions are subject to a 10% penalty under the Joint IRA, but not under the other options.
- You are a non-spouse – If you are not the spouse of the original owner of the IRA, you cannot consider the IRA as your own. Therefore, you cannot transfer funds into or out of the Legacy IRA or make other contributions to the IRA. You will not owe tax on the IRA’s assets until you start receiving distributions from it.
Once the inheritance and tax issues have been settled, you can move on to managing your inherited windfall. Cash inheritances are best used to settle high interest bills (credit cards are an example) or to pay off mortgage debt by making additional payments on the principal. Also consider setting up an emergency fund.
If you haven’t maximized your IRA or 401 (k) contributions, now is the time. Any remaining funds should be placed in liquid investments like money markets or laddered CDs to give you time to develop an investment plan, unless you have other specific investment needs like a 529 college plan for your children. Thanks to the TCJA, you can now also use 529 plans to accumulate tax-free savings for public or private elementary and secondary school fees, up to $ 10,000 per year, as well as college.
Legacy assets like stocks or real estate need to be built into your portfolio and then need to be rebalanced to get back to your risk profile. This may require selling some of the stocks you already own or the stocks you inherited to manage your risk.
With careful planning, you can get the most out of your inheritance. Resist the urge to splurge and you’ll be grateful later.
The IRS and the Treasury Department have extended the 2021 tax filing deadline from April 15 to May 17, due to the COVID-19 pandemic. In the interest of safety and to curb the spread of the coronavirus, all Taxpayer Assistance Centers (TACs) and face-to-face IRS services operate by appointment only. Taxpayers can call 844-545-5640 to make an appointment or find your local IRS TAC here. Check the IRS Coronavirus Tax Relief page for the latest updates.
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