# Inheritance: Definition, How It Works, and Taxes

![A multigenerational family in a field](https://www.investopedia.com/thmb/PC5RHVYmPRbiROF1H1vQqz3A_Wg=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/GettyImages-2154243675-e5448f3cae76417c874523267c5f8d29.jpg)

*— skynesher / Getty Images*

## What Is an Inheritance?

An inheritance is the set of assets that an individual bequeaths to their loved ones upon their death. It may be subject to inheritance taxes. A recipient may inherit the assets as an [heir](https://www.investopedia.com/terms/h/heir.asp), or they may be named as a [beneficiary](https://www.investopedia.com/terms/b/beneficiary.asp) in a will, retirement plan, or life insurance policy.

### Key Takeaways

*   An inheritance is the set of assets passed down after someone dies.
*   Most inheritances are simply cash in a bank account. Others consist of stocks, bonds, cars, jewelry, automobiles, art, antiques, real estate, and other tangible assets.
*   Those who receive an inheritance may be subject to inheritance taxes, where the more distantly related a beneficiary is to the decedent, the larger the inheritance tax is likely to be.
*   Six U.S. states levy inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
*   A decedent’s assets are divided according to their will through the probate process. If there is no will, the court will appoint an administrator to divide assets according to state laws.

## How an Inheritance Works

In most countries, inheritance assets are subject to [inheritance taxes](https://www.investopedia.com/terms/i/inheritancetax.asp), where beneficiaries may find themselves saddled with tax liabilities. The rates of an inheritance tax depend on a host of factors, including a beneficiary’s state of residence, the value of the inheritance, and the beneficiary’s relationship to the [decedent](https://www.investopedia.com/terms/d/decedent.asp).

The six U.S. states that levy inheritance taxes are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In most of these states, any assets that are bequeathed to a spouse are exempt from inheritance taxes. In some cases, children are also exempt, or they may face lower rates of taxation.

> **Fast Fact**
>
> An inheritance tax differs from an estate tax, which is a levy on the transfer of a deceased person’s estate. But estate taxes do not apply to assets left to a spouse or to federally recognized charities, in most cases.

[Beneficiaries](https://www.investopedia.com/articles/pf/07/beneficiary_form.asp) with no familial ties to the decedent are typically subject to higher inheritance taxes than beneficiaries who are closely related to the decedent.

Consider the following example: In Nebraska in 2024, a parent, grandparent, sibling, child, or other lineal descendants (including adopted children) paid an inheritance tax of 1% on assets exceeding $100,000. By contrast, relatives who were further removed from the decedent paid higher inheritance taxes up to a rate of 15%.

> **Fast Fact**
>
> Life insurance is not subject to inheritance taxes.

## The Probate Process

[Probate](https://www.investopedia.com/terms/p/probate.asp) is the legal process by which a decedent’s assets are divided among their heirs and beneficiaries, according to their will and state laws. If the decedent died with a will, that will is reviewed by a probate court, which appoints an [executor](https://www.investopedia.com/terms/e/executor.asp) for the decedent’s estate. The executor is then responsible for dividing the [estate](https://www.investopedia.com/terms/e/estate.asp) among the people named in the will and any [creditors](https://www.investopedia.com/terms/c/creditor.asp). Any disputes are resolved through probate court.

A person who dies without a will, or with an invalid will, is said to have died [intestate](https://www.investopedia.com/terms/i/intestate.asp). In this circumstance, the probate court will appoint an administrator of the estate to divide the assets according to state laws.

## Beneficiaries vs. Heirs

There is a distinction between a beneficiary and an heir. Beneficiaries are individuals named in a will, while heirs are people who are entitled to receive a decedent’s property by intestate succession, a set of rules created to [sort out inheritance matters](https://www.investopedia.com/articles/personal-finance/092515/i-just-inherited-money-now-what.asp) in the absence of a will.

## What Can You Do to Avoid Inheritance Taxes?

An inheritance tax is a state tax on the estate of a decedent. In most cases, inheritance taxes are based on the size of the inheritance and the beneficiary’s relationship to the deceased.

You can [reduce the inheritance tax burden](https://www.investopedia.com/tax-savings-strategies-for-wealth-transfer-8417034) on your beneficiaries by placing your assets in a [trust](https://www.investopedia.com/terms/t/trust.asp) or by gifting assets to your beneficiaries while you are still living. Another option is to take out a [life insurance](https://www.investopedia.com/terms/l/lifeinsurance.asp) policy and name your heirs as beneficiaries. Life insurance payouts are not subject to inheritance taxes.

## How Can You Avoid Taxes on a 401(k) Inheritance?

If you inherit a [401(k)](https://www.investopedia.com/terms/1/401kplan.asp) from a spouse, the conventional wisdom is to roll the sum into your own [individual retirement account (IRA)](https://www.investopedia.com/terms/i/ira.asp). This allows you to defer taxes until you start taking distributions.

If you inherit a 401(k) from a parent, it’s a little more complicated. The first step should be to consult the plan documents to determine what options are available. Most advisors caution against a lump-sum distribution, which would incur greater taxes than you would otherwise. A five- or 10-year distribution allows you to spread out the tax burden and allows [interest to compound](https://www.investopedia.com/terms/c/compoundinterest.asp). Some plans also allow distributions over your calculated [life expectancy](https://www.investopedia.com/terms/l/lifeexpectancy.asp), under very specific conditions.

## Can You Protect an Inheritance From a Chapter 13 Bankruptcy?

If you receive an inheritance within 180 days of filing [Chapter 13 bankruptcy](https://www.investopedia.com/terms/c/chapter13.asp), your trustee may require you to pay the sum into your bankruptcy plan. It’s more complicated for inheritances received more than 180 days after a bankruptcy filing—most courts have ruled that these windfalls should be repaid to creditors, but some courts have allowed the inheritor to keep the money.

## How Do I Find Out If I Have an Unclaimed Inheritance?

According to the U.S. government, the first step to finding unclaimed assets is to check your state’s [unclaimed money](https://unclaimed.org/) office. This is where the state collects records of unpaid wages, unclaimed bank accounts, and heirs who could not be located.

If you are uncertain about the contents of a will, the first step is to contact the decedent’s executor. In addition, their will should be filed with the local county recorder.

## What Is Probate?

Probate is a legal process that determines the validity and authenticity of a [will](https://www.investopedia.com/terms/w/will.asp). Probate is also the general administration of a deceased person’s will or the estate of a deceased person without a will. This involves collecting the deceased’s assets to pay any liabilities that remain on their estate and to distribute the assets to beneficiaries.

## The Bottom Line

While nobody enjoys thinking about their death, a well-structured estate plan can save your heirs and beneficiaries from a lot of legal unpleasantries. Moreover, it can also ensure that they receive as much money as possible, without losing too much to taxes.

> **Article Sources**
>
> 1.  Tax Policy Center. “[How Do State Estate and Inheritance Taxes Work?](https://web.archive.org/web/20240116135620/https://taxpolicycenter.org/briefing-book/how-do-state-estate-and-inheritance-taxes-work)”
>     
> 2.  Tax Foundation. "[Estate and Inheritance Taxes by State, 2024](https://taxfoundation.org/data/all/state/estate-inheritance-taxes/)."
>     
> 3.  U.S. General Services Administration. "[How to Find Unclaimed Money from the Government](https://www.usa.gov/unclaimed-money)."