For example, your mother may leave you her house, life insurance proceeds, and bank accounts to you as your inheritance in her will. She may leave her investment accounts and jewelry to your sibling, so that property would be their inheritance.
How an Inheritance Works
How an inheritance works depends on how assets are designated to be transferred. There are a few ways this can occur, including outside of probate, via a living trust, for example, or through probate. If there’s a will (and no living trust), it’s submitted to probate to start the distribution process. The probate court begins this process by authenticating the last will and testament and appointing the executor of the estate. The executor pays any debts and taxes owed by the deceased before distributing the remaining assets to their rightful beneficiaries. If a person dies without a valid will, or “died intestate,” their assets still go through the probate process. Their assets are divided up based on the state’s “intestate succession” laws instead of the deceased’s wishes. In most cases, assets go to their closest relatives.
What You Should Know About Inheritance Tax
If you receive an inheritance, you should be aware of the tax laws that will apply. You could potentially pay various taxes on an inheritance, such a state inheritance tax. Six U.S. states have an inheritance tax:
IowaKentuckyMarylandNebraskaNew JerseyPennsylvania
Surviving spouses are always exempt from inheritance taxes. In some states, children may also be exempt or face a lower tax rate. Beyond that, the amount of inheritance tax you pay depends on your relationship with the deceased and the state laws. Generally, the closer in relation you are to the deceased, the lower your tax rate. For example, in Kentucky, you’re exempt from all inheritance taxes if you’re a surviving spouse, parent, child, grandchild, brother, or sister. You pay a 4%-16% inheritance tax (with a $1,000 exemption) if you’re a niece, nephew, aunt, uncle, great-grandchild, daughter-in-law, or son-in-law. All other people and organizations pay a 6%-16% tax (with a $500 exemption). In this example, the tax rate increases along with the size of the inheritance.
Ways to Avoid an Inheritance Tax
Through proper estate planning, you can avoid or minimize the amount of taxes your beneficiaries have to pay. Three common strategies used to minimize taxes include:
Life insurance proceeds: Life insurance proceeds aren’t generally taxable as income to your beneficiaries. Irrevocable trusts: Some types of irrevocable living trusts help you avoid or reduce taxes because the property transferred into them doesn’t count toward your estate value. Gift tax exclusion: If you know your estate will be rather large when you die, you can minimize your future tax burden now through the gift tax exclusion. This rule allows you to give up to $15,000 a year to an individual, tax-free as of 2021. If you’re married, you and your spouse can give up to $30,000 per year to one person.
Inheritance Tax vs. Estate Tax
The main difference between an inheritance tax and an estate tax is who pays it. An inheritance tax is paid by the beneficiary receiving it. Estate taxes are paid out by the estate before assets are distributed to beneficiaries. There’s technically no federal inheritance tax, but there is a federal estate tax that applies to estates in excess of $11.7 million as of 2021 and $12.06 million in 2022. Surviving spouses are usually exempt from both inheritances and estate taxes. This chart highlights more differences between the two:
How to Find Out if You Have an Unclaimed Inheritance
You can find out if you have an unclaimed inheritance by visiting Unclaimed.org or MissingMoney.com. Both websites are endorsed by the National Association of Unclaimed Property Administrators (NAUPA) and allow you to search for unclaimed assets in your state. If you suspect you may have an inheritance from someone who’s recently died, you also can contact the executor of their estate to verify.
