When planning for your death, there’s one issue you may not have thought about—but that is critically important to your beneficiaries: will your loved ones have to pay taxes on what you leave them?
The answer depends on the types of assets you are passing down, how much you are passing on, and where you reside at the time of your death. For California residents, there are some important distinctions that can significantly impact your planning. Understanding how different accounts and assets are taxed can help you make informed decisions that minimize the tax burden on your beneficiaries.
In this article, we break down the tax implications of various types of inheritances—from cash accounts to retirement plans—so you can plan strategically and protect more of your wealth for the people you love.
Estate Taxes: Will They Apply in California?
There are three things we will never know with certainty: when you will pass away, what your assets will be worth at that time, and what the federal estate tax exemption amount will be when you die.
As of 2026, the federal estate tax exemption is scheduled to be approximately $15 million per individual (adjusted for inflation) and approximately $30 million for married couples with proper planning. However, under current law, the exemption is set to decrease in 2026 unless Congress acts. Because this amount can change, ongoing review of your estate plan is essential.
If your estate falls below the federal exemption amount in effect at your death, your estate will not owe federal estate taxes. If it exceeds the exemption, federal estate taxes will apply to the amount above the exemption before beneficiaries receive their distributions.
Important for California Residents
California does not impose a state estate tax or inheritance tax. This is a significant benefit for California residents. However, if you own property in another state, that state’s estate or inheritance tax laws could apply.
If you are married, it is critically important that your estate plan is reviewed and updated after the death of the first spouse. Proper planning allows a surviving spouse to preserve and use both spouses’ federal estate tax exemptions, potentially shielding tens of millions of dollars from federal estate tax.
Finally, keep in mind that estate tax is only one piece of the puzzle. Income tax and capital gains tax also play a major role in inheritance planning (and trust-level taxes may apply in certain situations). Even though you are planning for death, the strategy for each type of asset matters just as much as the overall size of your estate.
With that framework in mind, let’s explore how different assets are taxed when inherited.
Cash and Bank Accounts: The Simple Answer
When beneficiaries inherit cash from checking accounts, savings accounts, or money market accounts, they generally receive the funds without paying income tax on the principal.
For example, if you leave someone $50,000 in your savings account, they receive the full $50,000 without federal or California income tax consequences.
There is one exception: if the account earns interest after your death but before distribution, that interest is taxable income to the recipient. However, the original balance itself is not taxable.
Because of this straightforward treatment, liquid cash accounts are among the simplest assets to inherit from a tax standpoint.
Investment Accounts: The Step-Up in Basis Advantage
Taxable brokerage accounts holding stocks, bonds, or mutual funds receive one of the most powerful tax benefits in estate planning: the step-up in basis.
Here’s how it works:
When you purchase an investment, your “basis” is generally what you paid for it. If you bought stock for $10,000 and it grew to $100,000, you would normally owe capital gains tax on the $90,000 gain if you sold it during your lifetime.
However, when your beneficiaries inherit that stock, their basis typically “steps up” to the fair market value as of your date of death. In this example, their new basis would be $100,000. If they sell it immediately for $100,000, they owe no capital gains tax. If it appreciates further after your death, they would owe capital gains tax only on the post-inheritance growth.
This step-up applies for both federal and California capital gains tax purposes.
This benefit can significantly influence gifting strategies. In many cases, it may be more tax-efficient to hold highly appreciated assets until death rather than gifting them during your lifetime, since lifetime gifts carry over your original basis and may trigger larger capital gains taxes when sold.
Strategic planning is key.
Retirement Accounts: A More Complex Picture
Retirement accounts such as traditional IRAs and 401(k)s do not receive a step-up in basis. Instead, they are subject to income tax when distributed.
When a beneficiary inherits a traditional retirement account, they must pay ordinary income tax (federal and California, if applicable) on distributions. If you leave $500,000 in a traditional IRA to your child, every dollar withdrawn will generally be taxed as income to them.
The SECURE Act significantly changed the rules for most non-spouse beneficiaries. In most cases, inherited retirement accounts must now be fully distributed within 10 years of the original owner’s death. This compressed timeline can push beneficiaries into higher income tax brackets if withdrawals are not carefully planned.
Spouses have more flexibility. A surviving spouse can roll the inherited IRA into their own IRA and delay required minimum distributions based on their own age.
Roth IRAs offer a different advantage. Although the 10-year rule generally still applies, qualified Roth distributions are income-tax-free to beneficiaries. Because taxes were paid upfront, beneficiaries typically receive the funds without owing federal or California income tax.
Life Insurance: Generally Income-Tax-Free
Life insurance death benefits are generally income-tax-free to beneficiaries under both federal and California law.
If you have a $1 million life insurance policy, your beneficiary typically receives the full $1 million without paying income tax.
However, for federal estate tax purposes, if you own the policy on your own life, the death benefit may be included in your taxable estate. For very large estates, this could increase federal estate tax exposure.
Advanced strategies—such as using an Irrevocable Life Insurance Trust (ILIT)—can remove life insurance proceeds from your taxable estate when appropriate.
Strategic Planning Makes All the Difference
Understanding how each asset is taxed allows us to design an estate plan that minimizes taxes and maximizes what your loved ones receive.
In some cases, it may make sense to leave tax-efficient assets (like appreciated brokerage accounts) to certain beneficiaries while allocating retirement accounts strategically. In blended families or multi-generational planning, tax strategy becomes even more important.
As your Personal Family Lawyer® Firm serving California families, we help you create a comprehensive Life & Legacy Plan that considers:
- Federal estate tax exposure
- California tax implications
- Capital gains strategy
- Retirement account distribution planning
- Ongoing changes in tax law
Tax laws evolve. Your assets change. Your family circumstances shift. Estate planning is not a one-time event—it is an ongoing relationship and strategy.
We are here to ensure your plan works when your loved ones need it most.
Don’t leave your beneficiaries struggling with unexpected tax consequences. Click below to schedule a complimentary 15-minute discovery call and learn how we can support you: