Are TOD CD accounts subject to inheritance tax?
Certificates of deposit (CDs) are a low-risk way to save money for the short to medium term, and are a popular way for seniors to earn a modest return on their savings. As a result, CDs are often included in inheritance settlements, where they can be passed on in multiple ways. In order to avoid probate, many CD owners choose to name a transfer beneficiary on death (TOD) on their account, that is, someone who will automatically inherit it when the original owner dies. .
While this may help keep the CD out of probate proceedings, it does not allow you to avoid estate taxes. In this guide, we’ll explain how these taxes apply to CDs and why naming a TOD beneficiary is always a good idea.
Key points to remember
- Designating a transfer on death (TOD) beneficiary for your CD accounts may prevent some of your assets from being probated, as your CD assets will be transferred to your named TOD beneficiary without having to go through probate.
- Putting TOD beneficiaries on accounts does not mean that you or your heirs avoid estate taxes.
- The value of CDs counts toward federal and state estate tax thresholds, although heirs may avoid probate.
- The federal estate tax threshold is very high (in 2022, just over $12 million), and few states impose this tax. This means that the vast majority of estates do not have to pay inheritance tax.
Understanding Property Taxes
In order to understand when and why inheritance tax applies to TOD beneficiaries named on CD accounts, it is helpful to consider how inheritance tax works more generally.
When a person dies, the value of their estate is assessed and they may be subject to death and inheritance tax. For these to apply, however, an estate must be of a particular size, and it depends on where the person lived. Although the threat of estate and inheritance tax exists, in reality the vast majority of estates are too small to be subject to federal estate tax.
As of 2022, federal estate tax only applies if the deceased person’s assets are worth $12.06 million or more. It therefore only applies to a small number of people. Similarly, most states do not have an estate tax, which is levied on real estate, or an estate tax, which is imposed on those who receive an inheritance from an estate. That said, 12 states and the District of Columbia have estate taxes, and some of their exemption amounts are well below the federal threshold. For example, exemptions are only $1 million in Oregon and Massachusetts.
It is quite rare for an estate to be taxed. If you are one of the few Americans to leave an estate large enough for taxes to apply; however, it is important to understand how your inheritance tax will be calculated. Specifically, when it comes to TOD beneficiaries, it’s critical to understand that your estate estate and your taxable estate are two different things. A taxable estate is the value of everything owned at the time of death, whether or not it requires probate to transfer to a living beneficiary.
This means that while naming a TOD beneficiary on a CD account will keep the account out of probate, it will not help you avoid estate tax. Your CD will count towards the total value of your estate, whether or not you named a TOD beneficiary, and your heirs will be liable for this tax.
The vast majority of estates are not large enough to attract federal estate tax, and only a few states have their own estate taxes. Assets held in a CD, whether or not a TOD beneficiary is named, count towards tax thresholds.
Inherit a CD
The rules described in the previous section mean that very few heirs have to pay inheritance tax, either on their CDs or on any other assets. However, there are tax consequences associated with inheriting a CD.
Generally, interest earned by a CD before the death of the account holder is not taxable to the beneficiary, nor is the original amount that was deposited. But any interest earned after the death of the account holder would be taxable to the beneficiaries. If the amount of money in the CD is modest, the tax bill will likely be modest as well. But if you inherit a five or six figure CD, you may owe a significant amount of tax.
This rule applies whether an heir inherits a CD as a TOD beneficiary, co-owner or by estate. In other words, naming a TOD beneficiary can be a great way to simplify estate proceedings, it does not confer any tax benefits to your heirs, either for inheritance tax or income tax.
What are the inheritance tax thresholds?
As of 2022, federal estate tax only applies if the deceased person’s assets are worth $12.06 million or more – and therefore only applies to a small number of people. Twelve states and the District of Columbia have estate taxes, and some of their exemption amounts are well below the federal threshold.
Who can I designate as a TOD beneficiary?
Virtually anyone. A TOD beneficiary can be an individual, charity, business or trust. If the beneficiary is a person, it can be a parent, child, spouse, friend or anyone else you know. However, if you are married, your spouse may have special rights to your assets that take precedence over your named TOD beneficiaries.
Does naming a TOD beneficiary have tax benefits?
No. Although naming a TOD beneficiary may help your heirs avoid the probate process, it does not confer any tax benefit. It doesn’t help you avoid inheritance tax, and your heirs will still have to pay tax on CD income after you die.
Naming transfer on death (TOD) beneficiaries on your CD accounts can help some of your assets avoid probate because your CD assets will be transferred to your named TOD beneficiary without having to go through probate. However, this won’t help you (or your heirs) avoid estate taxes, because the value of your CDs counts toward federal and state estate tax thresholds, even if they don’t have to go through certification.
The federal estate tax threshold is high and few states impose this tax. In other words, the vast majority of estates do not have to pay inheritance tax.