I received an inheritance: How is this money taxed?

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The amount of federal estate tax typically is determined by the amount of assets within the estate and the relationship of the beneficiaries to the deceased.

Spouses and nonspouses

Spouses typically may inherit an unlimited amount of assets free of federal estate taxes. Estates bequeathed to nonspouses, in contrast, may be subject to federal estate taxes and state estate and/or inheritance taxes depending on the level of assets within the estate.
For nonspousal heirs, in 2021, the federal estate tax is levied at a maximum rate of 40% after $11.7 million exemption (less any amount of the exemption used during the deceased's lifetime). For estate tax purposes, heirs typically value assets at the fair market value on the date of the deceased's death.
Note that some states impose estate and/or inheritance tax thresholds and tax rates that differ from those at the federal level. An estate planning attorney can advise you on taxation issues applicable to your particular circumstances.

Special rules for retirement accounts

In most instances, spouses who inherit individual retirement accounts (IRAs) may treat the IRA as their own and for traditional IRAs, must begin required minimum distributions (RMDs) after age 72. RMDs, from a traditional IRA must be taken annually thereafterFootnote 1 and are taxed as ordinary income for federal income tax purposes (state and local income tax treatment can vary). For Roth IRAs treated as the spouse's own Roth IRA, no RMDs would be required for the spouse's lifetime (but RMDs would be required for a nonspouse beneficiary who inherits the spouse's Roth IRA as described below).
Nonspouses, in contrast, may not delay RMDs from an IRA until they reach age 72. Nonspouses may transfer the IRA assets into an IRA held in the nonspouse's name (an "inherited IRA"). When taking distributions from an inherited IRA, distributions must generally be made within 10 years following the year of the original account owner's death. In some cases, eligible beneficiaries may take annual distributions, with the amount determined by the account balance and the beneficiary's life expectancy. The latter strategy may permit a larger portion of the account to remain invested and subsequently provide the potential to grow tax deferred. The tax treatment of distributions from an inherited IRA depend on the type of assets in the inherited IRA; if the inherited IRA has traditional IRA assets, the distributions are taxed as ordinary income for federal income tax purposes, whereas if the inherited IRA has Roth IRA assets, distributions are federally income tax-free. State and local income tax treatment may vary.
Similar rules apply to employer-sponsored retirement plans, such as 401(k) plans or 403(b) plans. If you inherit assets that are within an employer-sponsored retirement plan, you may want to contact the sponsoring employer to determine rules affecting beneficiaries.
Estate and inheritance taxes are a complicated issue. When determining how they apply to your situation, an experienced estate planning lawyer could be your most valuable asset.

Footnote 1 If you delay your first RMD to the year after you turn age 72, you will be required to take two RMDs in that calendar year.

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.

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