Those who have experienced settling an estate have seen how many different financial accounts and policies people can have. Passing away with stock, retirement accounts, life insurance policies, real estate, and other assets can create confusion and uncertainty about what is taxable. Specifically for beneficiaries who may not be directly involved, or those who have just received their entire inheritance, it is important to understand how the major ways of inheriting money can affect your taxes.
Key Takeaways
- Estate, inheritance, capital gains, and income taxes all could apply, depending on the type of asset received and the relationship to the deceased.
- Inherited retirement accounts often create ordinary income taxes, while Roth accounts and life insurance proceeds are typically received income-tax free.
- Stocks, real estate, and other non-retirement assets often receive a step-up in basis at death, which can significantly reduce the capital gains taxes.
- Understanding how each inherited asset is taxed can help you make smarter decisions about distributions, asset sales, and long-term planning.
Types of Taxes
There are four main taxes that could affect the transfer of money from a deceased person to their beneficiaries. They are the Estate Tax, Inheritance Tax, Capital Gains Tax, and Personal Income Tax. The Estate Tax has been popular in the last few years, albeit not too relevant for many people. In 2026, the federal government imposes an estate tax on personal estates over $15 million ($30 million for married couples). Once you exceed that amount, the estate may be taxed up to 40%. The estate technically pays this tax and not the beneficiaries. Ultimately, however, many who pass away with less than $15 million do not need to worry about the federal estate tax.
The Inheritance Tax could be relevant, especially for those here in Kentucky. There is no federal inheritance tax, and only 5 states impose this tax (KY included). An Inheritance Tax is technically paid by the beneficiary receiving the money. Kentucky specifically lays out rules on who pays the tax and at what rates; however, the common theme is the relationship with the deceased person. Spouses, kids, and grandkids generally are exempt, but friends, coworkers, cousins, or distant relatives could be subject to up to 16% in state taxes.
Finally, Capital Gains Tax and Personal Income Tax are important at the beneficiary level as well. Most people have a rough understanding of these tax systems, but it can get tricky understanding what assets fall under their Capital Gains or income tax rates and what do not. It is worth understanding that these inheritances, if taxable, would be in addition to your current capital gains and income tax situation. For example, the inheritance of one brother making 6-figures would be much more severely taxed than that of another brother who is not working. This is when the type of inheritance becomes important, since some accounts are taxed one way or another.
Inheriting Retirement Accounts
With the recent updates from the Secure 2.0 Act, the rules on inheriting a retirement account are very dependent on your relationship to the deceased. Ultimately, for a standard account like a traditional IRA or traditional 401k, the process is relatively straightforward. There is no tax consequence when transferring the account into your name, but once you start to withdraw from the account, you will be required to pay ordinary income tax at your tax rates. Especially with inheriting retirement accounts from parents, those distributions could come as soon as the year of the parent’s death.
Those who inherit Roth retirement accounts will not have any taxes to worry about. Roth accounts, by design, have already paid the taxes, so any inherited Roth account is essentially a tax-free gift to the beneficiary. This always creates some generational planning questions, especially if elderly parents have some Traditional IRAs they will never use. If their tax rate is less than yours, it may be worth asking if converting those to a Roth would save the entire family on taxes and let you inherit a tax-free account.
Inheriting Cash, Stock, and Property
Assets not in a typical retirement are also very common for inheritances. Cash, stock, and real estate are major examples of assets that are not necessarily tucked in a retirement account. As a result, capital gains tax at the beneficiary level starts to enter the picture instead. Cash is generally considered tax-free from capital gains since you cannot sell cash for more than you bought it (in theory). Stocks and real estate, however, could be taxable, depending on when the assets are sold.
Assets in this scenario generally receive a Step-Up in Basis. Remember, Capital Gains tax looks at the difference between the sale price and the purchase price. With a step-up in basis at death, the purchase price is effectively updated to the value at the date of death. This could be very helpful for assets that the decedent held for decades and would have incurred significant capital gains had they sold them before death. While real estate and stocks could be taxable to the beneficiary, the step-up could reduce or even eliminate the tax liability.
Just be mindful that the tax doesn’t occur until you sell the asset. If you sell it shortly after inheriting it, chances are the value is still similar to the date of death, and the capital gains tax would be negligible. However, if you hold it for years or decades, the capital gains tax is not calculated until it is sold.
Inheriting Life Insurance
Life insurance proceeds are generally tax-free, similar to inheriting cash. Many rules and policies could affect this, but in general, they can be treated as cash. This surprises people, since inheriting a large sum of money can feel like taxes should be involved. But similar to the Roth IRA, the taxes were technically already paid before death. As a result, these funds can be used more freely to settle estates, for personal use, or to cover taxes on other assets that may be subject to tax.
It is worthy of note that although life insurance is generally not taxable to the beneficiary, it often can be included in the total estate. For estates subject to estate tax, for example, life insurance could throw them over the threshold and indirectly cause more taxes.
Death and Taxes
There are always many moving pieces in successfully transitioning an estate to the next generation. Probate, retirement accounts, taxes, real estate, trusts, and more can create confusion about what is taxable and what is not. It is very important to ask your accountant, advisor, and estate planning attorney what is best for your situation. Question each asset you receive and seek out ways to simplify and potentially even reduce the taxes in the situation. Some may be easier to control than others, but the goal is for an inheritance to be a blessing and not a curse.
TC Falkner 