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What Are the Tax Consequences of Inheriting a CD?

Byline profile imageWritten by Mark Henricks
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Byline profile imageEdited by Mo Mozuch
Byline profile imageEdited by Arturo Conde, CEPF®
Updated on
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If you inherit or leave a certificate of deposit (CD), some taxes may apply. The CD’s principal passes without income tax, but any interest earned after death is taxed as ordinary income to the heir. Federal estate tax only applies if the estate exceeds the exemption, and there is no federal inheritance tax, though some states do impose their own. A transfer-on-death setup can help avoid probate but does not change the tax rules.

If you have questions, consider asking a financial advisor for help preparing your estate plan or handling any potential taxes on an inherited CD.

CD Inheritance Basics

A CD is a fixed-income savings tool offered at many banks and credit unions. It allows a saver to set aside a specific amount of money for a specific length of time ranging from weeks to years and, in return, earn a pre-set rate of interest. Federal deposit insurance makes CDs as safe as anything you can do with your money. However, CD interest rates, while often higher than a savings account, are likely to lag behind inflation. And there may be a penalty if you withdraw money before the end of the term.

Many savers and investors appreciate CDs for their safety and convenience. They may well be part of your estate. Or, if you’re going to inherit a CD from someone, you may be faced with the potential tax consequences. CDs can present tax complications depending on factors such as the size of the CD and where the deceased and heir reside.

Inherited CD Tax Considerations

Three types of taxes may come into play when you’re looking at the tax consequences of inheriting a CD: income, estate and inheritance taxes. The first of these is the one most likely to be encountered, but likely won’t be a major cost. The second may be relevant, but probably only to a small number of cases. The third is least likely and will be the responsibility of the heir who receives the bequest.

Income Tax

Advisor discussing the tax consequences of inheriting a cd with a client.

The IRS does not regard the value of an inherited CD as taxable. That is, if you receive a $10,000 CD, you won’t have to increase your reported income by $10,000. The interest on the CD is another matter, however. Interest earned before the deceased’s death is not considered income to the recipient of the CD. However, income earned by the deposit after the death is regarded as ordinary income taxable at the recipient’s usual tax rate. Because of the relatively modest interest rates paid by many CDs, the tax bill on interest earned is unlikely to be much except in the case of an unusually large CD inheritance.

It is worth noting that many banks will waive the early withdrawal penalty if the inheritor of a CD wants to withdraw funds before the term of the deposit is up. And, if the bank does charge a penalty on an inherited CD, the recipient of the bequest can likely deduct the amount of the penalty from taxable income for that year.

Estate Tax

Tax law does provide for federal estate taxes on inherited assets, but the tax only applies to estates over a certain amount. Currently, that amount is $13.61 million, so it’s only relevant to relatively few estates. There is no federal inheritance tax.

A handful of states also have estate taxes. Some use the same floor as the federal estate tax for their levies. However, a few have much lower thresholds. Oregon, for example, taxes estates over $1 million.

Inheritance Tax

A similarly small number of states have inheritance taxes, which the recipient of the bequest has to pay. Only Maryland has both estate and inheritance taxes. Generally speaking, due to their overall rarity and the use of thresholds below which taxes don’t apply, estate and inheritance taxes will not be concerns for most estates or heirs.

Transfer on Death

Some CD owners set them to transfer ownership automatically to a beneficiary on the owner’s death. This can be an effective way to avoid having the CD pass through probate, a process likely to add months or years to the time required to distribute funds to heirs, as well as incurring extra costs. However, transfer on death arrangements won’t affect inheritance or estate taxes on an inherited CD. Nor will they have any effect on taxes that could be due on post-death interest earned.

Options for Managing an Inherited CD

If you inherit a CD, you may be able to keep it until it matures. This lets you continue earning the interest rate set when the CD was opened, which can be helpful if rates have dropped since then. The bank will simply change the ownership to your name, and the terms will stay the same.

You can also choose to withdraw the money before the CD matures. Many banks will waive early withdrawal penalties for inherited CDs, but you should confirm this with the bank before taking out the funds. If a penalty does apply, you may be able to deduct it from your taxable income for that year.

Another option is to reinvest the money into a new CD or another type of savings or investment account. This could help you select a term and rate that fits your financial goals. You might choose a shorter-term CD for flexibility or a longer-term CD for potentially higher rates.

Before deciding what to do, think about your financial needs and current interest rates. If you don’t need the cash right away, keeping or reinvesting the CD could help you grow your savings. If you need immediate access to the money, withdrawing it might be the better choice.

Bottom Line

A woman calculating the tax consequences of inheriting a cd.

Passing on a CD usually has few tax issues. The main tax is income tax on interest earned after the owner’s death, which the heir must pay. Federal estate tax only applies to very large estates, and while most states do not tax heirs, some have estate or inheritance taxes with lower limits than the federal rules.

Tax-Planning Tips

  • If you’re planning to leave a CD as part of your estate or expect to inherit one, you may want to talk over the possible tax impacts with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • You can estimate your next federal, state and local income tax bill in just a few minutes with the help of SmartAsset’s tax calculator.

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