Understanding Inheritance Taxes: What You and Your Beneficiaries Need to Know
July 09, 2026
When planning for your death, there is one issue that may not be top of mind, but matters greatly to the people you love: will your beneficiaries have to pay taxes on what you leave behind? The answer is not simple because it depends on the kinds of assets you own, the total value of what you leave, and where you live at the time of your death. Understanding how different assets are taxed can help you make informed decisions and reduce the tax burden on your loved ones.
In this article, I will explain the tax treatment of several common types of inherited assets, from cash accounts to retirement plans, so you can plan strategically and help preserve more of your wealth for the people you love.
Estate Taxes: Will They Apply?
There are three things we can never know with certainty, no matter how proactive your planning may be: when you will die, what your assets will be worth at that time, and what the federal estate tax exemption amount will be when that happens. Over the past 25 years, the federal estate tax exemption has ranged from as low as $675,000 to as high as $15,000,000 per person.
That means that in 2026, the federal estate tax applies only to estates worth more than $15 million for an individual or $30 million for a married couple. If your estate is below that threshold, your estate will not owe federal estate tax. If it exceeds the exemption amount, estate taxes must generally be paid before beneficiaries receive distributions. And if you are married, it is especially important to review and update your estate plan after the first spouse dies so that the full exemption of the first spouse can be preserved and used properly.
It is also important to remember that some states impose their own estate or inheritance taxes, and those state thresholds may be much lower than the federal exemption. A complete plan should take both federal and state tax rules into account.
Finally, estate tax is only one piece of the picture. Income tax and capital gains tax may also apply when assets are inherited. Trust taxation may matter as well, though that is a topic for another article. The point is that planning for inheritance is not just about estate tax. You also need a strategy for each category of asset you own.
With that in mind, let’s look at how different inherited assets are commonly taxed.
Cash and Bank Accounts: The Straightforward Answer
When beneficiaries inherit cash from checking accounts, savings accounts, or money market accounts, they generally receive favorable tax treatment. If you leave someone $50,000 from your savings account, they typically receive the full $50,000 without federal income tax.
There is one small exception. If the account earns interest after your death but before the funds are distributed, that interest is taxable income to the beneficiary. However, the principal balance itself remains income tax free.
Because of that simple treatment, cash accounts are often among the most tax efficient assets to inherit. That is one reason many estate plans include liquid assets alongside other investments.
Investment Accounts: The Benefit of a Step Up in Basis
Taxable investment accounts, including brokerage accounts holding stocks, bonds, or mutual funds, often receive what is called a step up in basis. This can provide a significant tax advantage to your beneficiaries.
Here is how it works. When you purchase an investment, your basis is generally the amount you paid for it. If you bought stock for $10,000 and it later grew to $100,000, you would normally owe capital gains tax on the $90,000 gain if you sold it during your lifetime. But when your beneficiaries inherit that stock, their basis is typically stepped up to the fair market value on the date of your death, which in this example would be $100,000. If they sell it immediately for $100,000, there is no capital gains tax due. If they wait and the value increases further, they would pay capital gains tax only on the amount above $100,000.
This step up in basis is one of the most powerful tax benefits in estate planning because it can effectively erase the capital gain that built up during your lifetime. Your beneficiaries pay capital gains tax only on appreciation that occurs after they inherit the asset.
Understanding this rule can also affect your gifting strategy. In some situations, it may be more tax efficient to hold highly appreciated assets until death instead of gifting them during life, because a lifetime gift usually carries over your lower basis to the recipient. That means the person receiving the gift may later owe tax on gains that built up while you owned the asset.
Retirement Accounts: A More Complicated Picture
Retirement accounts such as 401(k)s and traditional IRAs involve more complicated tax rules. Unlike many other inherited assets, these accounts do not receive a step up in basis, and they often create income tax consequences for beneficiaries.
When a beneficiary inherits a traditional retirement account, they generally must pay ordinary income tax on the distributions they take. If your daughter inherits a $500,000 IRA, for example, she would owe income tax on every dollar she withdraws. The actual tax rate depends on her income bracket, which is why the timing of withdrawals can matter so much.
The SECURE Act of 2019, later amended in 2022, changed these rules significantly for many beneficiaries. In the past, many non spouse beneficiaries could stretch distributions over their life expectancy, which often helped keep them in lower tax brackets and allowed taxes to be spread out over a longer period. Now, in many cases, all retirement benefits must be distributed within 10 years of the account owner’s death. That shorter timeline can force larger withdrawals and may push beneficiaries into higher tax brackets if distributions are not handled carefully.
Spouses who inherit retirement accounts often have more flexibility. A surviving spouse can usually roll the inherited account into their own IRA and defer required distributions until reaching the applicable required minimum distribution age.
Roth IRAs are different. Although beneficiaries may still be subject to the 10 year distribution rule, qualified Roth IRA withdrawals are generally income tax free. Because the taxes were already paid before the money went into the account, your beneficiaries can usually receive the funds without owing income tax on those withdrawals.
Life Insurance: Usually Income Tax Free
Life insurance death benefits typically pass to beneficiaries free of income tax, which makes life insurance an important estate planning tool. If you own a policy worth $1 million, your beneficiary will usually receive the full $1 million without paying income tax on it.
There is, however, an important estate tax consideration. If you personally own the life insurance policy on your own life, the death benefit may still be included in your taxable estate. For very large estates, that could create estate tax exposure even though the beneficiary does not owe income tax on the proceeds. In those cases, more advanced strategies such as an irrevocable life insurance trust may help remove the policy from the taxable estate.
Strategic Planning Makes a Meaningful Difference
When you understand how different assets are taxed at inheritance, you can structure your estate more thoughtfully. For example, you may choose to leave tax efficient assets like cash or appreciated brokerage assets to certain beneficiaries, while leaving retirement accounts to beneficiaries who are in a better position to manage the income tax consequences.
As your Personal Family Lawyer® Firm, we help you create a Life & Legacy Plan that looks not only at what you are leaving behind, but also at how those assets should be structured to help minimize taxes and maximize what your loved ones receive. Tax laws can change, and your circumstances can change too. That is why ongoing strategic guidance can make the difference between a plan that simply exists and a plan that truly works when your loved ones need it.
To learn more about how we can assist you and your loved ones, schedule a FREE discovery intake call using our online form, or call 501 300 7526 (PLAN) to schedule your FREE discovery intake call.
This article is a service of Phoenix Law, your trusted Arkansas Life & Legacy Planning and Arkansas estate planning attorneys in Sherwood, Arkansas. We do more than draft documents.We help you make informed and empowered decisions about life and death, for yourself and the people you love. That is why we offer a Life and Legacy Planning Session, during which you can become more financially organized than ever before and make the best possible choices for the people you love. You can begin by calling our office today to schedule a Life and Legacy Planning Session.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking legal advice specific to your needs, that advice must be obtained separately from this educational material.
