Taxes on Inherited Money from Non-Qualified Investments
If you have money in a non-qualified investment account, or are the listed beneficiary on one, familiarize yourself with the potential tax consequences faced by receiving the proceeds of that account after the death of the original owner. Most investment accounts contain contractual language allowing the owner to name a particular individual or organization as beneficiary, thereby instructing the financial institution to transfer the account value after his death. Even though non-qualified retirement accounts contain a mixture of previously-taxed and untaxed money, that status is only applicable to the original account owner. Beneficiaries who receive proceeds from a non-qualified account become responsible for income taxes on the full value of the account.
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Qualified vs. Non-Qualified
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For tax purposes, investment accounts are qualified or non-qualified. In a qualified account, none of the money has been taxed; contributions result in a dollar-for-dollar income tax deduction and taxes are deferred until distributions occur. In a non-qualified account, the money invested has already been taxed and comes from the owner's personal savings. The sum total of all interest earned or growth realized must be added to the owner's taxable earnings for the year.
Inheriting an Account
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If the owner of a non-qualified investment account dies, and you are the named beneficiary of that account's proceeds, the money gets distributed to you in either a single lump sum or a series of equal payments over the course of several years. You owe income taxes on whatever amounts you actually receive during a tax year.
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Spousal Beneficiaries
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If you are the beneficiary of a non-qualified retirement account and the owner's spouse, unlike other beneficiaries, you may choose to continue the account in your own name. Maintaining the account under the original terms and conditions often presents an advantage because the income taxes that would otherwise be due immediately can be further delayed until your own retirement withdrawals begin.
When No Beneficiary Exists
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If there is no living beneficiary at the time of the account owner's death, the entire proceeds of the account get transferred to his estate and are processed according to probate law. Depending on the size of the owner's estate, a potentially large portion of the account may be lost to estate and inheritance taxes. Additionally, completing the probate process may take a significant amount of time if the overall estate exceeds $1,000,000. Upon conclusion of the probate process, the remaining balance of the deceased owner's estate gets transferred to his heirs based on instructions provided by his last will and testament or by a probate court. In such situations, the recipient heirs are likely to owe income taxes for the full value of the cash and possessions transferred to them.
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