Right before I sat down to have this conversation with Taylor Wolverton, I walked out of a first meeting with a woman that was carrying a worry. She was sure her kids would lose a big piece of what she left them to taxes. We spent about ten minutes on how step-up in basis works, and you could watch the stress leave her face. That discussion is the reason this post exists. 

Inheritance tax is one of the most confusing topics in retirement planning. Part of the problem is that “taxes on inheritance” sounds like one rule, when it’s closer to a dozen. Cash follows one rule, stocks follow another, your IRA has its own, and so does your house. Taylor runs financial planning and tax strategy at our firm (she’s a CFP® and an Enrolled Agent), and she and I went through the accounts people most often leave behind.  

Do You Pay Taxes on Inheritance? Start With the Three Taxes 

When people say “inheritance tax,” they usually mean one of three different taxes, and only one of them touches most families. 

Federal estate tax. The estate itself pays this, before anything reaches the heirs, and only on the amount above the exemption. Under current law that exemption is $15 million per person, or $30 million for a married couple, and it rises with inflation. Above that line the rate climbs fast, from 18% to 40%. If your numbers land above that line, there are strategies built for it, and that deserves its own conversation. 

State estate and inheritance taxes. 12 states and Washington, D.C. charge their own estate tax. 5 states (Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania) charge an inheritance tax, which the person receiving the money pays. North Carolina, where most of our clients live, has neither. 

Regular income tax. This is the one that reaches almost everyone. Some of what you inherit gets added to your taxable income, and some of it never does. The type of account decides which, so that’s where we’ll spend our time. 

One quick definition first. Your estate is everything you leave behind: retirement accounts, bank accounts, CDs, your home, other property and land, and even life insurance proceeds. Add it all up, and if the total sits under $15 million per person, estate tax is unlikely to be your problem and income tax is the thing to plan around. 

Inherited Cash: The Simplest Case 

Taxes on inherited money sitting in a bank account are as simple as it gets, because there aren’t any. Taylor’s example: her mom leaves her $50,000 in a checking account, and Taylor receives $50,000 with no income tax owed. 

I hear this one often. Someone tells me they just inherited a couple hundred thousand dollars, and my first question is always what kind of account it came from. When the answer is a bank account, the whole amount is theirs. 

The risk with cash is probate. A bank account with no beneficiary, and not titled to a trust, goes through the court process before anyone can touch it. A payable-on-death or transfer-on-death designation solves that, and most people have never added one to their checking and savings accounts. One call to your bank or credit union takes care of it. 

Inherited Stocks and Step-Up in Basis 

This is the rule that changes people’s plans. 

Say I bought $500,000 of NVIDIA in a regular brokerage account at Schwab or Fidelity, and today it’s worth $1 million. If I sell it, I owe long-term capital gains tax on the $500,000 gain, typically at 15% or 20%. 

Now say I hold it, I pass away, and my son inherits the account. His cost basis steps up to the market value on the date of my death, which is $1 million. If he sells the next week for $1 million, his capital gains tax on the inheritance is zero. The $500,000 of growth that happened on my watch is wiped clean. 

Tax only comes back on growth after he inherits. If he holds the stock and it climbs to $1.5 million before he sells, he owes long-term capital gains on that new $500,000. Inherited assets are treated as long-term no matter how soon you sell, which helps. 

This matters most with concentrated positions. Plenty of retirees sit on one big stock they won’t sell because the tax bill would hurt too much. The heir gets a clean slate and the chance to diversify without that bill. If you’re the one inheriting, decide what that position should be doing for you before you hold it out of loyalty. 

Step-up in basis covers stocks, ETFs, mutual funds and similar holdings in a taxable brokerage account. It does not cover retirement accounts, which brings us to the biggest one. 

Inherited IRA Taxes: The 10-Year Rule 

Traditional IRAs and 401(k)s are where most of our clients hold the most money, and inheritance works completely differently here. The original owner never paid income tax on those dollars, so the tax passes to whoever inherits them. Every dollar you withdraw from an inherited traditional IRA counts as ordinary income. 

For most non-spouse beneficiaries, the account has to be empty by December 31 of the tenth year after the owner’s death. Inherit in 2026, and the deadline is December 31, 2036. 

A second rule sits on top of that one. If the original owner had already reached the age for required minimum distributions (73 today), you also have to take a yearly minimum in years one through nine, then finish emptying the account in year ten. Miss a required distribution and the penalty is 25% of the amount you should have taken, reduced to 10% if you fix it within the correction window. The IRS waived these penalties on inherited IRAs from 2021 through 2024, that relief has ended, and the rules are enforced now. 

Spouses get more flexible options, and a few other beneficiaries qualify for exceptions too. Most adult children land squarely in the 10-year rule. 

Where the strategy lives. Say you’re 58 and you inherit a $1 million IRA from your 85-year-old mother. The simple approach is to take about $100,000 a year for ten years. If you plan to retire in two years, though, that $100,000 lands on top of your salary during your highest-earning years. 

A better plan might be to take only the required minimum while you’re still working, then take larger withdrawals once the paycheck stops and your bracket drops. You still have eight years to empty the account. It’s the same money and the same deadline, with a potentially much smaller tax bill, and that kind of sequencing belongs inside your financial plan instead of a December scramble. 

Roth IRA Inheritance: Our Favorite Account to Leave Behind 

The Roth IRA is Taylor’s favorite account. Withdrawals from an inherited Roth are generally free of income tax, as long as the original owner’s Roth met the five-year holding rule. 

The 10-year rule still applies, but there’s no yearly minimum. You can leave the account alone, let it compound tax-free for the full ten years, and take the whole balance in year ten. If you don’t need the money, that’s usually the approach we’d suggest looking at first. 

This changes how I think about Roth conversions in our tax strategy meetings. Clients often tell us they can only convert $20,000 this year before they’d jump a bracket or trigger IRMAA (the Medicare premium surcharge), and they wonder whether a conversion that small is worth the effort. Here’s a hypothetical. You convert $20,000 a year for ten years at an assumed 6% annual growth rate, and the Roth reaches about $264,000. Your heir inherits it, leaves it untouched for the full ten years at the same assumed 6%, and withdraws about $472,000 tax-free. These are illustrations, not projections, and real returns vary and can be negative, but the direction is clear: small, steady conversions can grow into a meaningful tax-free inheritance. 

The catch is that your heirs need to know to leave it alone. A ten-minute conversation now protects years of tax-free growth later. 

Inherited Property Taxes: Real Estate Gets a Step-Up Too 

Real estate follows the same step-up in basis rule as stocks. Taylor’s example: her mom buys a house for $100,000, and thirty years later it’s worth $500,000 when Taylor inherits it. That $400,000 of appreciation disappears for tax purposes. If she sells right away, she owes no income tax on the sale. If she holds and sells later, only the growth after the date of death is taxable. 

Taylor added a practical tip here: get an appraisal at the time of death. Pinning down what a property was worth years ago is hard, and a dated appraisal documents your new basis if you ever sell or get audited. 

The Rest of the List 

• Life insurance: Proceeds are generally income-tax-free to the beneficiary. 

• Non-qualified annuities: There’s no step-up. The gain inside the annuity is taxable to you as ordinary income, the same as it would have been to the owner, and withdrawals come out of earnings first. 

• HSAs: A spouse can keep using an inherited HSA as their own. For anyone else, the account stops being an HSA, and its full value becomes taxable income in the year of death. Paying the deceased’s unpaid medical bills from it within a year reduces that amount. 

• Bonds: The interest is taxable, and the principal is not. 

Where to Start 

Pull your statements and note 2 things for each account: which tax bucket it sits in, and who the beneficiary is. Those 2 facts drive nearly everything above, and they’re the first things Taylor’s team looks at in our annual tax strategy meetings, for your own retirement and for the people you’ll leave it to. 

If you’ve inherited money, expect to, or want your plan set up so your heirs aren’t guessing, visit the Contact Us page at pomwealth.net and we’ll set up a call. When you reach out, we’ll also send you a free copy of our book, The Peace of Mind Pathway, which walks through our process from start to finish. Sometimes we end that first call by telling someone they’re already in good shape, and either way you’ll leave knowing where you stand.