Table of Contents
- What Is an Inheritance?
- Key Takeaways
- How an Inheritance Works
- The Probate Process
- Beneficiaries vs. Heirs
- What Can You Do to Avoid Inheritance Taxes?
- How Can You Avoid Taxes on a 401(k) Inheritance?
- Can You Protect an Inheritance From a Chapter 13 Bankruptcy?
- How Do I Find Out If I Have an Unclaimed Inheritance?
- What Is Probate?
- The Bottom Line
What Is an Inheritance?
Let me explain to you what an inheritance really is. It's the collection of assets that someone leaves to their loved ones when they pass away, and yes, it might come with inheritance taxes. You could receive these assets as an heir, or you might be specifically named as a beneficiary in a will, a retirement plan, or a life insurance policy.
Key Takeaways
Here's what you need to know right away: an inheritance is simply the assets passed down after someone dies. Most often, it's cash from a bank account, but it can include stocks, bonds, cars, jewelry, automobiles, art, antiques, real estate, and other physical items. If you receive an inheritance, you might face inheritance taxes, and the farther removed you are from the deceased in terms of relationship, the higher those taxes could be. Only six U.S. states impose these taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. The deceased's assets get divided based on their will through probate, or if there's no will, a court appoints an administrator to handle it according to state laws.
How an Inheritance Works
In most places, including the U.S., inheritance assets can hit you with taxes, leaving beneficiaries to deal with those costs. The tax rates depend on where you live, how much the inheritance is worth, and how closely related you are to the person who died. Those six states—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—are the ones that charge inheritance taxes. Usually, assets left to a spouse are exempt, and sometimes children get exemptions or lower rates too.
Remember, an inheritance tax isn't the same as an estate tax, which taxes the transfer of the entire estate but often skips spouses or charities. If you're not family, you'll likely pay higher inheritance taxes than close relatives. For instance, in Nebraska for 2024, close family like parents, grandparents, siblings, children, or adopted kids pay just 1% on amounts over $100,000, but more distant relatives could pay up to 15%. And here's a key point: life insurance payouts aren't subject to inheritance taxes.
The Probate Process
Probate is the legal way assets get divided among heirs and beneficiaries, following the will and state laws. If there's a will, the probate court reviews it and appoints an executor to handle distribution to those named and to pay any creditors. Disputes get sorted out in court. If someone dies without a will—or if it's invalid—they're intestate, and the court picks an administrator to divide things per state rules.
Beneficiaries vs. Heirs
You should understand the difference here: beneficiaries are people specifically named in a will, while heirs are those who get the property through intestate succession rules when there's no will.
What Can You Do to Avoid Inheritance Taxes?
An inheritance tax is a state levy on the deceased's estate, based on the inheritance size and your relationship to them. To cut down on taxes for your beneficiaries, put assets in a trust or gift them while you're alive. Another solid option is getting a life insurance policy and naming heirs as beneficiaries, since those payouts skip inheritance taxes.
How Can You Avoid Taxes on a 401(k) Inheritance?
If you inherit a 401(k) from your spouse, the smart move is to roll it into your own IRA to defer taxes until you withdraw. From a parent, it's trickier—check the plan documents first. Avoid lump-sum distributions to dodge big taxes; instead, opt for five- or 10-year distributions to spread the burden and let interest grow. Some plans allow distributions over your life expectancy under certain conditions.
Can You Protect an Inheritance From a Chapter 13 Bankruptcy?
If you get an inheritance within 180 days of filing Chapter 13, your trustee might make you pay it into the plan. After 180 days, it's more variable—some courts say pay creditors, others let you keep it.
How Do I Find Out If I Have an Unclaimed Inheritance?
Start by checking your state's unclaimed money office for records of unpaid wages, bank accounts, or missing heirs. If you're unsure about a will, contact the executor or check the local county recorder where the will should be filed.
What Is Probate?
Probate verifies a will's validity and handles the administration of the estate, whether there's a will or not. It involves gathering assets, paying debts, and distributing what's left to beneficiaries.
The Bottom Line
No one likes planning for death, but a solid estate plan saves your heirs from legal headaches and maximizes what they get by minimizing taxes.
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