Avoiding probate and avoiding tax are two different achievements, and families regularly confuse them. A joint bank account, a payable-on-death designation or a named beneficiary on a retirement plan can move money to the next generation without a court proceeding. None of those arrangements, on its own, decides whether a tax is owed. At the federal level the distinction rarely bites, because the federal estate tax reaches only estates above a high exemption. At the state level it can, and the households most surprised are often the ones that did everything they were told would keep things simple.
The states that tax what heirs receive
Most states impose no death tax at all. A smaller group levies an estate tax, measured by the size of the whole estate. A handful, including Pennsylvania, New Jersey, Kentucky, Nebraska and Maryland, impose an inheritance tax, which is measured by what each heir receives and usually depends on that heir’s relationship to the person who died. Under an inheritance tax, the question is not whether the estate is large but who is receiving each asset and how it was held.
Pennsylvania illustrates how far such a tax can reach. Transfers to a surviving spouse are taxed at zero. Transfers to children, grandchildren and other lineal descendants are taxed at 4.5 percent, transfers to siblings at 12 percent, and transfers to most other heirs at 15 percent. The tax applies whether or not the asset passes through probate. Pennsylvania real estate, bank and investment accounts, vehicles and valuable personal property, business interests and transfers made within a year of death are generally taxable. Anything passing to a surviving spouse, life insurance on the life of the person who died, qualifying charitable gifts and certain government and military death benefits are generally not.
The joint account and the retirement plan
The joint account is the arrangement families most often assume is exempt. A parent adds a son or daughter to a checking or savings account so that bills can be paid and the money passes directly at death. In a state with an inheritance tax, that account is usually still taxed. In Pennsylvania, where a parent and one child hold an account jointly, the survivor is generally taxed on one half of the balance, the share treated as belonging to the parent. If the joint interest was created within one year of death, the treatment is harsher: the full value is taxable, less a small exclusion. Joint property held with a spouse is exempt. Leeson & Co., an estate-planning firm in Bethlehem, addresses the question directly in a breakdown of which assets Pennsylvania taxes at death, describing a convenience account as one that was meant to make things easy and instead becomes a taxable transfer nobody planned for.
Retirement accounts are more complicated, and the rules are frequently misstated. Nationally, the bigger issue for heirs is usually income tax: distributions from an inherited traditional IRA or 401(k) are generally taxable income to the beneficiary, and most non-spouse beneficiaries must now empty an inherited account within ten years. A state inheritance tax can apply on top of that.
Pennsylvania’s treatment turns on access rather than on the type of account alone. An IRA is generally taxable if the person who died could have withdrawn from it without the 10 percent federal early withdrawal penalty, which usually means the person had reached 59 and a half or was disabled. It is generally exempt if the person was younger and not disabled. Employer plans such as a 401(k), a pension or a profit-sharing plan raise a separate question: whether the person who died actually had the right to take the money during life, which depends on the plan’s terms and on whether the person had left that employer. A 401(k) can therefore be exempt where an IRA held by the same person is not. Roth accounts are split. The contributions are taxable regardless of age, because they could always have been withdrawn without penalty, while the earnings are not taxable where the person died before 59 and a half and was not disabled.
Life insurance tends to run the other way. Pennsylvania exempts insurance on the life of the person who died, whether it is paid to a named beneficiary or to the estate. A policy the person owned on someone else’s life is another matter; it is generally taxable at its cash surrender value.
Why titling decides so much
The common lesson across states is that titling and beneficiary choices, not just total wealth, drive the result. Two families with identical savings can face very different tax bills purely because of how accounts were registered, who was named as beneficiary and when those changes were made. A change made in the last year of life can carry a different result than the same change made years earlier.
That makes a periodic review of account titles and beneficiary forms one of the more valuable and least expensive steps in estate planning. It is also one of the easiest to postpone, because nothing appears to be wrong until an heir receives a tax notice. Families who check how each account is held, and why, while the owner can still change it, keep a choice that their heirs will not have.
