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Whether a beneficiary has to pay tax on the proceeds of a life insurance policy depends on whether the proceeds are paid in a lump sum or in installments with interest. Similarly, if you inherit a bank account, you don't pay income tax on the funds in the account, but if they start earning interest, the interest payments are your taxable income. For example, if you inherit a house and rent it out to tenants, you must pay income tax on the rent payments you receive. Once a beneficiary owns an asset, any income produced by that asset is taxable income. Tax on Income Generated by Inherited Property the account was opened and contributed to at least five years earlier.įor more on this, see Inheriting Retirement Accounts: Legal Overview.the money was contributed by the person who created the Roth account (that is, it isn't a return on the investment of contributed funds), or.People don't have to pay income tax on amounts they take from a Roth account they inherited if: Roth accounts are funded with money that has already been taxed, so the accounts are treated like other inherited property. Money that a beneficiary withdraws from a Roth IRA or 401(k) plan, however, is generally not taxable income.
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Other beneficiaries can change the account into an "inherited IRA" and withdraw the money over several years, spreading out the income tax as well, but, with a few exceptions, they must withdraw the full amount in the account within ten years. Surviving spouses who inherit a retirement account can defer the tax by rolling over the account into a retirement account of their own. The tax will be due with the person's regular annual income tax returns (both state and federal). Income tax on the funds is deferred until money is withdrawn from the account, either by the original contributor or by the person who inherits the account.Ī beneficiary who withdraws money from an inherited account must report that money as ordinary income. Either contributions are made with pre-tax dollars, or the contributor gets a tax deduction for the contribution. The money contributed to traditional IRAs and 401(k) plans is generally not taxed before it is put in.
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Tax-Deferred (Traditional) Retirement Plans
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Whether an inherited account is taxable depends on the kind of account. In this case, it concerns funds in retirement accounts, which may be taxed when they're withdrawn by inheritors. Exception for Money in Retirement Accounts - IRAs and 401(k) Plans Whether the property passes under the terms of a will or trust, or the inheritor was a designated beneficiary (for example, a payable-on-death bank account), it's not taxable income. It doesn't matter how the property passes to the inheritor. Someone who inherits a $500,000 bank account doesn't have to pay any tax on that amount. The Basic Rule: Inheritances Aren't Taxed as IncomeĪn inheritance can be a windfall in many ways-the inheritor not only gets cash or a piece of property, but doesn't have to pay income tax on it. This comes as a happy surprise to many inheritors. The good news for people who inherit money or other property is that they usually don't have to pay income tax on it.