How can I protect my inheritance from taxes?

The first question I often hear when someone receives an inheritance is: How should I handle this, and how am I taxed? Receiving an inheritance can come with unexpected tax implications if you’re unprepared. However, with the right planning and understanding, you can reduce the tax burden and help protect your inheritance for the long term.

Types of Taxes on Inheritance

It is great to start with the various ways in which inheritance may be taxed:

• Estate Taxes: Paid by the estate, not the beneficiary. Only estates valued over $13.99 million (per person, federally) are subject to this tax.
• Inheritance Taxes: Only apply in a few states, including New Jersey, Nebraska, Maryland, Pennsylvania, and Kentucky. The beneficiary pays these taxes. Rates often depend on your relationship to the decedent.
• Income Taxes: May apply depending on the asset. Inherited retirement accounts are taxable when funds are withdrawn. Cash, life insurance, real estate, and investments are typically not considered income.

Using Trusts to Protect Inheritance

Trusts are powerful tools for protecting inheritance and preserving wealth across generations. Despite the common misconception, they aren’t reserved for the ultra-wealthy, anyone looking to protect their assets and control how they’re distributed can benefit from establishing a trust.

• Revocable Trusts: These allow you to avoid probate and maintain privacy, but they don’t reduce estate taxes. Revocable trusts are essentially an extension of you, enabling assets to pass outside of probate while you retain control during your lifetime.
• Irrevocable Trusts: These permanently remove assets from your estate, offering both control and potential tax advantages. However, they come with strict rules and limitations, including those related to gifting.
• Spousal and Generation-Skipping Trusts: Designed to reduce tax liability and preserve wealth for multiple generations, these trusts offer long-term protection and strategic tax benefits.

If You Inherit a Trust

If you’re inheriting through a trust, it’s important to understand how it’s structured and what your responsibilities are as a beneficiary. Consulting a professional can help you navigate the details and make confident, informed decisions.

Understanding the Step-Up in Basis

One of the greatest tax benefits is the “step-up in basis,” which applies to assets such as real estate and stocks. In most cases, the cost basis is adjusted to the market value at the time of the original owner’s death. This eliminates unrealized gains and reduces potential capital gains taxes when selling shortly after inheriting. Note: This does not apply to retirement accounts!

Tax Strategies for Inherited Retirement Accounts

If you inherit a traditional IRA or 401(k), you cannot avoid taxes on the account. Most non-spouse beneficiaries must withdraw all the funds within 10 years and pay income tax. A well-timed withdrawal strategy spread over several years can help manage the tax impact.

Gifting Money to Reduce a Taxable Estate

Whether you’re planning your own estate or assisting loved ones with theirs, gifting can be a strategic way to reduce a taxable estate over time. It allows wealth to be transferred gradually and more tax-efficiently.

• In 2025, individuals can gift up to $19,000 per person, per year without triggering gift tax. For couples, that limit doubles to $38,000 per recipient.
• Payments made directly to educational or medical institutions on someone’s behalf do not count toward the annual gift limit.
• Larger gifts are allowed by using a portion of the lifetime exemption, which aligns with the federal estate tax threshold.

Life Insurance and Estate Planning

Life insurance is usually income-tax free, but the death benefit may still count in the estate for tax purposes. To exclude it from the estate, families sometimes use an Irrevocable Life Insurance Trust (ILIT). These were more common when the estate tax exemption was lower but can still be useful today.

Charitable Contributions as a Tax Strategy

If giving back is a priority for you or your family, charitable contributions can be a meaningful part of your estate plan. Strategies like charitable remainder trusts and donor-advised funds let you support causes you care about while also helping reduce estate taxes.

Are you ready to protect your inheritance?

If you have questions or want to explore how these strategies could apply to your situation, we’re here to help. Schedule a consultation with one of our financial advisors today to build a personalized plan that aligns with your goals and protects your financial future.

Shawna Theriault, CFP®, CPA, CDFA®
Senior Financial Advisor, Wiser Wealth Management