Naming a beneficiary for a bank account can be an effective way to ensure that your beneficiary receives money when you die without having to go through probate first. When you leave money to someone in this manner, the beneficiary may or may not have to pay taxes on the inheritance.
Payable on Death
When you open a bank account, the bank may give you the opportunity to name a beneficiary for the account. This is known as a payable on death option. To set this up, you have to fill out a single document naming the beneficiary and possibly a contingent beneficiary to inherit the money in the account when you die. Once you set up this type of account, the money will transfer ownership to the beneficiary when you pass away. The beneficiary will usually only have to show identification and a death certificate to get the money.
When a beneficiary receives money in this manner, he will not have to worry about paying inheritance taxes to the federal government. The Internal Revenue Service, or IRS, does not impose an inheritance tax. However, some states do charge an inheritance tax. This means that depending on where you live, you may have to pay taxes to the state government based on the amount of money that is in the bank account when you take over its possession.
Estate Tax Factors
When one of your beneficiaries receive money from a payable on death account, the money may be subject to the estate tax. Even though the federal government does not impose an inheritance tax, it does have an estate tax. This is a tax that is based on the total value of the estate of the deceased individual. The money in the account will be added to all of the other assets in the estate to determine if estate taxes are due. As of 2011, if the total value of the estate exceeds $5 million, then estate taxes are due.
When you engage in estate planning, you may be able to minimize the amount of money that your beneficiaries have to pay in taxes. For example, you could buy a life insurance policy that is designed to provide enough money to pay the taxes on an inheritance. If your estate is close to the $5 million threshold, you may give some of the money away before you pass away to get under the estate tax exemption level.