When a loved one passes away, they typically leave behind an inheritance for their loved ones. The inheritance can have monetary or sentimental value, or a combination of both.
Here is a list of the most common types of inherited assets:
Qualified plans include plans such as pensions, profit sharing plans, 401(k)s, 4039(b)s, SEPs, SIMPLEs, and traditional IRAs. Typically, after the death of a participant in the retirement plan, the beneficiary must withdraw a minimum amount each year. These plans contain rules dealing with issues such as the age of the owner, the person named as the beneficiary, and the relationship between the owner and the beneficiary. The distributions are usually taxed at the beneficiary’s normal income tax rate with the exception of non-deductible contributions to IRAs.
Roth IRAs and Roth 401(k)s
As with the qualified plans mentioned above, the beneficiary must withdraw a minimum amount each year. However, the distributions are typically tax-free income.
Deferred Compensation, Payments from Employment Contracts and Other Investment Income
These types of assets are typically taxed at the beneficiary’s normal income tax rate.
Annuities can be fixed, indexed, or variable. Any appreciation over the initial investment is typically taxed at the beneficiary’s normal income tax rate. However, most annuities provide beneficiaries with options, which may provide a means to spread the tax liability out over multiple years.
The death benefit from a life insurance policy is typically income tax free for the beneficiary.
Cash, Bank Accounts and CDs
These are typically the most uncomplicated type of inheritance. They are not tax free, but any appreciation occurred by the accounts have typically been covered by the deceased through their taxes during their lifetime.
Stocks, Bonds, Mutual Funds, Exchange-Traded Funds, Closed-End Funds, and Unit Investment Trusts
These assets, if held in a taxable personal investment account, are usually eligible for a step-up or step-down in cost basis. As a result, the cost basis for tax purposes will be equal to the fair market value as of the date of the deceased’s death. Selling the asset as soon as you receive it results in little to no capital gains. If these assets are held in a qualified plan as listed above, they follow the same set of rules as those for the qualified accounts.
Personal Residence, Rental Properties, Other Real Estate, Vehicles and Other Personal Property
As with stocks and bonds, the cost basis for tax purposes for these assets will be equal to the fair market value as of the date of the deceased’s death.
Assets Held in Revocable Trust
These assets are included in the deceased’s estate and received a step-up cost basis, similar to the assets owned under an individual name.
Assets Held in Irrevocable Trust
These assets are typically excluded from the deceased’s estate and not subject to a step-up in cost basis. As a result, selling these assets at a later date could result in increased capital gains taxes. However, irrevocable trust assets can be excluded from the deceased’s estates when calculating estate taxes.
While this list is not exhaustive, it does provide a general overview of the common types of inherited assets.