A payable on death (POD) account is an estate planning tool that provides a way for an individual to pass money to a beneficiary without the necessity of probate when they die. A beneficiary is named on the account, and they can access the money by presenting the original death certificate to the bank or institution where the account is held. The executor of the deceased's estate does not have any control over the funds.
There's no limit to the amount of money or the number of accounts that can be passed to beneficiaries in this way. However, beneficiaries should be aware of the potential tax and other consequences of inheriting a POD account before they start spending any money.
Payable on Death Income Taxes
The value of a POD account generally will not be included in your taxable income because bequests aren't taxable as income. Any income earned by the POD account prior to the date the bequeather died is reported on their final income tax return.
Income earned between the date of death and the date the beneficiary takes over ownership of the account is also reported on the estate's income tax return. After that, any earnings related to the account become taxable to the beneficiary.
POD Inheritance Taxes
The federal government does not impose an inheritance tax. The beneficiary pays inheritance taxes at the state level if the decedent held it or died in one of the six states that have an inheritance tax.
As of 2021 Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey and Maryland collect inheritance taxes.
Each state has it's own tax rates and criteria. For instance, the inheritance tax rate is as much as 18% in Nebraska, so a beneficiary might owe the government $18,000 if they inherited a $100,000 account. But there's a bit of good news here—the more closely related to the decedent someone is, the less of a tax rate they'll pay.
Surviving spouses are typically exempt from this tax entirely, and a few of the states exempt the deceased's children as well. Beneficiaries who aren't related to the decedent may pay higher rates, depending on the state.
Although POD accounts bypass probate, the decedent's probate estate and taxable estate are two different things. A taxable estate is the value of everything owned at the time of death, regardless of whether it requires probate to transfer to a living beneficiary.
If the account owner's estate is large enough to be subject to federal or state estate taxes, the provisions contained in the will or living trust documents might indicate whether there is a requirement to contribute to the payment of any estate tax bills. The estate is technically responsible for paying any estate tax, but this isn't to say that the deceased's personal wishes won't direct otherwise.
Generally, most estates are not large enough to incur estate taxes.
As of 2021, estates with values over $11.7 million must pay a federal estate tax on the portion of their values over this amount—all value up to this amount is exempt.
Twelve states and the District of Columbia have estate taxes, however, and some of their exemption amounts are much lower. For example, exemptions are just $1 million in Oregon and Massachusetts.
If the account owner did not have a will or trust, the laws of the state where they died dictate whether there is a requirement to contribute to the payment of any estate tax due. This is generally true even if the account wasn't part of the decedent's probate estate.
Payable on Death Capital Gains Taxes
Whenever a person inherits anything that appreciates in value and sells it, they can be liable for capital gains tax on the profits. This tax is levied on the difference between the basis—the normal cost of an asset—and the sales price.
The asset's value might be significantly more than the purchase price. If the difference is large, it could result in a large tax bill. If the asset is sold for a loss, there wouldn't be taxes due.
Keep in mind that tax deductions can be claimed from capital losses, but only in limited amounts—$3,000 (married filing jointly), $1,500 (married filing separately or single) or the amount on line 21 of Schedule D, whichever is less.
Account Owner's Outstanding Bills
Technically, a decedent's debts should be paid from the estate as part of the probate process. Probate assets can be liquidated to provide payment to creditors, but this rule applies to debts and obligations in the decedent's sole name.
The only way a beneficiary would be contractually obligated to pay any bills is if they're a guarantor of the debt, such as co-signing on a credit card or auto loan.
And remember, the executor of the decedent's estate has no control over a POD account because it never becomes part of the probate estate. But liabilities as an account beneficiary can also depend on state law in some states. An affidavit may need to be signed confirming that the POD account owner did not have any outstanding debts prior to collecting the money.