Advertiser Disclosure

Investing

Inheritance Tax: How It Works and Who’s Exempt

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Written By

Inheritance tax is a state tax charged by only six states when someone receives an inheritance from someone who has died. Unlike estate tax, which can be levied by both the federal government and states, inheritance tax comes out of the beneficiary’s pocket — not out of the estate. The rate varies depending on how much you inherit and your relationship to the deceased.

However, many beneficiaries are exempt from paying this tax. If you’re getting an inheritance, you’ll want to know whether you’ll owe inheritance tax — and if so, how much you may have to pay.

How inheritance tax works

The federal government doesn’t have an inheritance tax — this is a state-specific levy, and it is only present in six states. As of 2020, the following are states with inheritance tax:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

In states that have taxes on inheritance, a person who inherits money or property after someone dies may owe taxes on it. Inheritance tax only applies when the beneficiary inherits property from someone who lived in a state that has an inheritance tax. It matters only where the deceased lives, not the beneficiary.

For example, if you live in Florida and you inherit money from an uncle who lives in Kentucky, which is one of the six states that does impose an inheritance tax, you may owe inheritance taxes to the state of Kentucky. However, if you live in Kentucky and inherit assets from an aunt who lives in Florida, a state that does not have an inheritance tax, you would not owe inheritance tax.

How much is inheritance tax?

How much you’ll pay in inheritance tax can depend on multiple factors. This includes your relationship to the person who has died (also known as the decedent) and how much you inherit, as well as the laws in the state in which the decedent lived. If you inherit an individual retirement account (IRA), additional factors come into play.

State inheritance tax rates

Each of the six states that impose an inheritance tax has its own brackets and rates. The tax rate is effectively a percentage of the value of the assets you are inheriting from the decedent. Nebraska has the highest cap, at 18%, while Maryland’s is the lowest, at 10%.

State

Inheritance tax rates

Iowa0% to 15%
Kentucky0% to 16%
Maryland0% to 10%
Nebraska1% to 18%
New Jersey0% to 16%
Pennsylvania0% to 15%

Inheritance tax exemptions

In some cases, certain beneficiaries are exempt from paying inheritance tax based on their relationship to the person who has died. Spouses are always exempt, meaning that if your spouse dies and leaves you all of their worldly possessions, you won’t owe any inheritance tax, no matter where you live.

Children may be exempt as well, or they may have to pay taxes on only part of the inheritance. Charitable, religious and educational organizations are also usually exempt from paying inheritance tax. There are also certain situations that may exempt someone from inheritance tax. In Pennsylvania, for instance, if a parent inherits property from a child age 21 or younger, the inheritance tax rate is 0%.

Additionally, some states offer exemptions on some amount of inheritance before taxes are due. In Kentucky, for instance, a niece or nephew of the deceased would be exempt on the first $1,000 of inheritance before owing taxes, while a cousin or nonrelative would be exempt on the first $500. A spouse, parent, child, grandchild, sibling or half sibling would owe no inheritance taxes. In Nebraska, close relatives (parents, grandparents, children and siblings) are exempt on the first $40,000 of inherited assets. For other relatives, such as aunts, uncles, nieces and nephews, the exemption is lower, at $15,000, and the tax increases to 13%.

IRAs and inheritance tax

If you inherit an IRA, how much you’ll owe in taxes will depend on the situation:

  • If you inherit an IRA from your spouse: You can leave the money where it is or roll it into an inherited IRA or your own IRA, and you don’t have to take required minimum distributions unless you choose to do so. As a spouse, you owe no inheritance taxes. You may owe income taxes depending on your spouse’s age and what you choose to do with the IRA.
  • If you inherit an IRA from a nonspouse: Whether you’ll owe taxes in this situation depends on the state. You may owe inheritance tax on a traditional IRA, but in some states it will depend on whether the deceased was under age 59 ½ or over age 59 ½. It will also depend on your relationship to them. You may also (or only) owe income taxes on distributions.

“This is why I recommend making the IRA or qualified plan the first source for any charitable bequests at death, using beneficiary designations,” said Michael Whitty, a CFP in Chicago. “The charity pays no estate, inheritance or income taxes.”

Inheritance tax vs. estate tax: What’s the difference?

Inheritance tax and estate tax are very similar, in that both are assessed after someone dies. “Estate taxes and inheritance taxes are both a type of tax on the transfer of wealth,” Whitty said. However, there are key differences between the two types of taxes.

With inheritance tax, the person or organization that inherits the assets pays the taxes, and they pay only on what they inherit. Their tax rate varies depending on their relationship to the deceased. In Pennsylvania, for instance, direct descendants pay 4.5% on inheritances, siblings pay 12%, and other heirs pay 15%.

With estate tax, on the other hand, any taxes owed are paid by the estate when someone dies, and those taxes are based on the total value of the estate on the date of death. While inheritance tax is limited to only six states, estate tax can be levied by the federal government and/or states. As of 2020, 12 states and the District of Columbia impose an estate tax.

The federal government exempts estates that do not exceed $11.58 million in 2020, meaning that most people won’t owe estate taxes to the IRS when they die. At the state level, the exemption is often lower. In Oregon, for instance, the state estate tax only exempts estates that do not exceed $1 million.

Can states have an inheritance tax and an estate tax?

States can have both an inheritance tax and an estate tax, but only one does: Maryland. (The state of New Jersey used to also have both taxes, but the state repealed its estate tax in 2018.)

Having both taxes means that the estate might have to pay taxes to the IRS and to the state, and then beneficiaries might have to pay out of pocket again on any assets they inherit from the estate. That said, Maryland exempts estates of up to $5 million in value, and many direct relatives of the deceased are exempt from inheritance taxes.

How to minimize inheritance tax

One common way to reduce inheritance taxes is to give some of your estate away before you die so there’s less to inherit. Each year, you’re allowed to gift up to $15,000 to any individual before you have to worry about gift taxes. This is true for each donor and each donee, so you and your spouse could each give $15,000 to a child for a total of $30,000 per child, or you could give a combined $60,000 to an adult child and their spouse in a tax year.

You can also gift non-cash assets, such as investments or property. “This can help transfer wealth without having to be subject to the inheritance tax,” Whitty said.

Luckily, with only six states assessing an inheritance tax, there’s a good chance your loved ones won’t have to pay anything, particularly if you’re leaving everything to direct descendants (like your children). If you’re concerned about the inheritance taxes your beneficiaries may pay, a financial planner or estate attorney can help you determine the best strategy for reducing their tax burden.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Advertiser Disclosure

Investing

The Best Passive Income Ideas for 2020

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Written By

The idea behind passive income is that you can earn money over time without actively being involved in anything day to day. There may be work involved in the setup, but once your passive income earner is up and running, you get income on a regular basis without daily effort.

Passive income is important because it can both supplement your regular paycheck and act as an income safety net if you lose your job. It can also be an additional revenue stream once you retire. In short, passive income is a powerful tool to have in your financial portfolio.

How to make passive income

To earn passive income, you will need to set up a situation that brings in continuous income over time. This could be anything from a rental property that generates rental income each month to an e-book that puts money in your pocket every time another copy sells.

Passive income opportunities are plentiful, but some of them are easier (or more successful) than others. You’ll have to ponder your skills, what strategies might be easier or more available to you (some of them require cash, while others call for time and talent) and how much time you have to get something started before deciding on a passive income stream.

If you’ve got cash but no time, for instance, you might be able to get involved in real estate or peer-to-peer lending. If you’ve got artistic talent and are willing to invest the time, you might consider creating a print-on-demand product that you can sell.

10 passive income ideas to consider

1. High-yield savings and money market accounts

Earning interest on your money is a reasonable way to generate some passive income, particularly if it’s cash that’s just sitting in the bank. To do this, make sure your emergency fund (you do have an emergency fund, right?) is in an interest-earning savings account or money market account. In either type of account, you can earn between 1% and 2% on your cash savings.

2. Cashback cards and websites

A variety of financial products and websites allow you to make money by spending money in a particular way — either via a credit card with cashback rewards or by doing your shopping through an online portal that pays you a percentage of your purchases back in cash. (Or you can do both at the same time for two passive income streams.)

Look for a cashback credit card paying at least 1% on all purchases and preferably greater rewards in certain categories. Then, shop via an online portal like Rakuten (formerly Ebates), which will pay you a percentage of purchases with participating retailers, such as Petco and Lands’ End.

3. Peer-to-peer lending

Peer-to-peer lending platforms, such as Prosper, allow you to loan money to individuals or small businesses via the platform and, in turn, earn interest, typically at a rate higher than you’d find at a bank. Your returns will depend on how much risk you’re willing to take, and you can spread your money out over multiple loans with multiple risk profiles. Prosper states that its loans have historically returned an average of 5.10%, while Funding Circle, another peer-to-peer lender, estimates its historic returns at 5% to 7%, even after the 1% servicing fee.

The downside is that borrowers could default on their loans and you could lose your principal. But sites rate borrowers by credit score and other factors to help you determine how much risk you’re taking. “It’s not as risky as having all [your money] in the stock market,” said Manny Hernandez, CEO of global manufacturer Omni, Inc. “It’s the share economy coming into play.”

4. Dividends

In terms of true passive income, it doesn’t get much more passive than dividends, which are distributions made from a portion of a company’s earnings to investors in that company. If you’re invested in companies that pay dividends, you’ll receive periodic cash payments.

That said, dividend investments tend to have different goals than other kinds of investments, and you shouldn’t swing your entire portfolio over to dividend stocks just to realize this kind of passive income. A financial advisor can help you determine what kind of role dividend investments can play in your financial plan.

5. Real estate rentals

Some people invest in real estate as a passive income investment. If you own a property and rent it out, for instance, you’ll receive income each month from your renters. But owning real estate isn’t labor-free if you’re managing the property, which involves finding and screening tenants and being available for emergency repairs and other assistance.

“To truly be passive, you’d want somebody else doing it and you get mailbox money,” said Matt Chancey, a CFP in Tampa, Fla. “But the more passive it becomes to you, typically the lower the income stream, because there are other professionals in the value chain doing part of the work for you.”

6. Affiliate marketing

If you’re willing to plug certain products or services online and on social media, you can earn a tiny piece of the profit if people click your link or make a purchase. This is called affiliate marketing, which is essentially earning a commission by promoting other people’s products.

You can do this via a blog you write or another social media account, such as an Instagram account with a lot of followers. The trick is that you need an audience — but once you have that audience, you can use affiliate marketing to monetize it.

“This isn’t a get rich quick scheme,” said Donovan Gow of home DIY site HouseAndTool.com. “You’ll have to learn a lot about SEO, website building and layout, keywords and link building in order to build traffic to your website. However, this is all very doable.”

There are various formats for affiliate marketing, including pay-per-click, pay-per-sale and more. You can check out affiliate networks like ClickBank, CJ Affiliate (formerly Commission Junction), Google AdSense, Infolinks and Rakuten LinkShare to learn more.

7. Online courses

Do you have a particular skill, or is there a kind of training you regularly give to your employees or coworkers? You can package it into an online class or tutorial. Once it’s produced, you’ll receive income every time someone purchases it. You can use a site like Udemy, Teachable or Skillshare to make your course available to the paying public.

“Building a truly substantive and penetrating online course is essentially a one-time cost,” said Jason Patel, founder of college and career prep company Transizion. “Sure, you’ll have to pour a lot of time and effort into building the course, but once it’s made, you’ll only have to update it with design and curriculum.”

In addition, an online course gives you bragging rights, a portfolio item and a way to attract customers to your brand. “Even if the course itself doesn’t sell, you can offer the course as a lead generation tool, thus transforming it into a powerful passive marketing tool,” Patel said.

8. Print-on-demand business

Another example of passive income is a print-on-demand business, which allows you to list items for sale without having any of the items in stock. For instance, you might offer t-shirt designs, artwork or allow someone to upload a photo that is then printed on an article of their choice. (Picture your pet’s face on a pair of socks.)

When a person purchases the item from your store, the order is automatically sent to a print-on-demand fulfillment provider that prints the product and ships it out to your customer on your behalf. “My business is about 90% automated,” said Justin Blase, founder and owner of Ted’s Vintage Art, which sells vintage maps. “I also sell these products on Etsy, Amazon, eBay and Houzz.com.”

9. E-books

Like an online class, a self-published e-book gives you the chance to showcase your expertise and offer it to the world in the form of a purchasable product. “Some say self-published e-book publishing isn’t as lucrative as it once was,” Gow said. “While that may be true, it’s still probably the simplest way to begin generating passive income.”

That’s because once you’ve written the book, your work is available in perpetuity. “Our company has books that we self-published years ago that continue to generate hundreds of dollars a month in profit with absolutely no marketing or effort on our end,” Gow said.

And while many self-publishers offer only Kindle versions of their books, a surprising number of people still prefer to purchase a hardback book, and it’s easy enough to make one available via a service like Printful.

10. Selling stock photos

If you’re passionate about taking photos, another passive income idea to look into is selling your photos on a stock photo platform. Stock photos are what companies use in varying content, such as their website, internal and external publications and marketing materials.

To make money from stock photography, you simply would upload your photos to a stock photography site. Different sites have different requirements in terms of who can upload photos, and rates may vary. Some sites to check out include Alamy, iStock, Can Stock Photo and Shutterstock.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Advertiser Disclosure

Banking

How Regulation D Affects Your Savings Accounts

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Written By

If you have a savings or money market account, you may have noticed that there’s a rule that goes with it — no more than six transfers or withdrawals per month from the account. It may feel oddly specific, but it’s true for all savings accounts at all banks and credit unions. Congratulations, you’ve experienced Regulation D.

Note: Due to the coronavirus pandemic and its widespread implications, the Federal Reserve has temporarily amended Regulation D to delete the six-transaction-limit on “convenient” transfers. This amendment allows institutions to immediately suspend enforcement of this rule and allows consumers to immediately take advantage of this waiver.

This opens up the opportunity for folks to avoid further penalties when they need to access funds from a savings account during this time. This suspension applies to all savings accounts across financial institutions, many of which are also temporarily waiving excessive transaction fees anyways. Check whether your bank offers COVID-19 relief here.

What is Regulation D?

Regulation D refers to the Federal Reserve’s reserve requirements for depository institutions — or, more plainly, how much money a bank needs to hold in reserve as a percentage of the total amount of money it owes to its customers. So, for instance, currently banks must keep a minimum reserve of 3% of the total amount over $16.3 million and 10% of the total amount over $124.2 million.

Why is this important? “It’s designed to make sure that banks have an appropriate amount of money in reserve,” says Robert Föehl, J.D., executive-in-residence for business law and ethics at Ohio University’s College of Business. “It’s about making sure that banks are safe and sound.”

As part of these reserve requirements, banks must classify what types of deposit accounts they have and keep reserves accordingly. For accounts categorized as savings accounts, Regulation D limits bank customers to six transfers or withdrawals per month. This rule is in place, in part, because banks aren’t required to hold a reserve against savings accounts.

In general, transaction accounts, which include checking accounts, are considered riskier types of deposits. “You write a check; that check could bounce,” Föehl says. “There’s more risk to the financial institution to have transaction accounts than to have savings accounts.”

Savings accounts are considered safer for banks because — by definition — people aren’t using them for all of their financial business. If you’re writing all your checks on your savings account, it’s not really a savings account. “You can’t call something a savings account if it’s a transaction account,” Föehl says. “This is where the limit comes into play.”

Regulation D’s limits are also a way of encouraging people to save, says Mayra Rodríguez Valladares, a financial regulation consultant and trainer in New York City. “The downside is that if you wanted to withdraw more than six transactions a month you could incur some kind of penalty,” she says.

How does Regulation D work for customers?

If you go over your allowed six transfers or withdrawals, your bank may charge you a fee. If you do it regularly, they may convert your account to a checking account or even close your account entirely.

In general, any account that limits “convenient” transfers and withdrawals is considered a savings deposit account and would be covered by Regulation D. These include:

  • Savings accounts: Deposit accounts in which a customer earns interest on the money they deposit, which often have lower minimum deposits.
  • Money market accounts: Deposit accounts in which a customer earns interest on the money they deposit, and the interest is typically higher than a savings account.

These accounts also come with a “reservation of right” requirement, in which the bank reserves the right, at any time, to require seven days’ written notice of an intended withdrawal — but banks don’t typically do this in practice.

Transactions that are limited under Regulation D

Essentially, Regulation D caps transactions that are considered easy for you to initiate without having to drive to a bank or visit an ATM. That would include:

  • Preauthorized, automatic transactions — including those from a savings account for overdraft protection or for direct bill payments
  • Telephone transfers
  • Withdrawals initiated by fax, computer, email or the internet
  • Transfers made by check, debit card or another similar method made by the depositor and payable to third parties

How can I get around the limits of Regulation D?

You may bypass the six-withdrawal limit under certain conditions, including if you’re willing to travel to your local branch in person. “It’s getting to be less and less of a problem,” Valladares says. Transactions that don’t go against your limit include:

  • Transfers and withdrawals made in person at the bank
  • Withdrawals and transfers requested by mail
  • ATM withdrawals and transfers
  • Transfers and withdrawals initiated by telephone, where the withdrawal gets disbursed as a check and mailed to the depositor

How to avoid trouble with Regulation D

If you’re feeling hemmed in by the six-transaction limit of your savings accounts, there are a few ways to work around it:

  • Visit your bank branch or ATM. Transactions made at your local branch or from your bank’s ATM don’t go against your monthly limit — this is the simplest way to avoid trouble with Regulation D.
  • Plan ahead. If you know you’ll need a certain amount of money in a month, don’t drag it out over multiple transactions — get what you need in fewer trips. Withdraw more at a time.
  • Decline overdraft protection. Generally, overdraft protection works by dipping into your savings account if you write a check that your checking account can’t cover. That counts as one of your six transactions, but if you decline overdraft protection, it can’t happen.
  • Get a checking account. If you need more than six transfers or withdrawals, save yourself some trouble and get a checking account with unlimited transaction power.
  • Don’t pay bills from your savings or money market accounts. Your checking account makes the most sense for regular payment withdrawals. Reconsider setting up a direct debit from your savings account, which will count toward your six transactions.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.