Certificates of deposit (CDs) are a low-risk way of putting some money aside for the short- to medium-term future and are a popular way for seniors to earn a modest return on their savings. As a result, certificates of deposit are often included in inheritance settlements, where they can be passed on in a number of ways.
To avoid probate, many CD owners choose to name a transfer-on-death (TOD) beneficiary to their account—that is, someone who will automatically inherit it when the original owner passes away. While doing this can help keep the CD out of probate proceedings, it doesn’t allow you to avoid estate taxes.
In this guide, we’ll explain how these taxes apply to CDs and why naming a TOD beneficiary is still a good idea.
Key Takeaways
- Naming a transfer-on-death (TOD) beneficiary for your certificate of deposit (CD) accounts can keep some of your assets out of probate, because the assets in your CDs will pass to your named TOD beneficiary without having to go through probate.
- Putting TOD beneficiaries on accounts does not mean that you or your heirs avoid estate taxes.
- The value of CDs counts toward federal and state estate tax thresholds even if heirs can avoid probate.
- The federal threshold for estate taxes is very high (as of 2024, it is $13.61 million), and few states impose this tax. This means that the vast majority of estates don’t have to pay estate taxes.
Understanding Estate Taxes
To understand when and why estate taxes apply to TOD beneficiaries named on CD accounts, it’s worth reviewing how estate taxes work more generally.
When a person dies, the value of their estate is assessed, and they may be subject to estate taxes and inheritance taxes. For these to apply, however, an estate must be of a particular size, and this depends on where the person lived. While the threat of estate taxes and inheritance taxes does exist, in reality, the vast majority of estates are too small to be charged a federal estate tax.
In 2023, federal estate tax only applied only if the assets of the deceased person were worth $12.92 million or more—so it only applied to a small number of people. To account for inflation, the threshold increased to $13.61 million in 2024. Similarly, most states don’t have estate tax, which is levied on the actual estate, or an inheritance tax, which is assessed against those who receive an inheritance from an estate. That said, 12 states and the District of Columbia do have estate taxes, and some of their exemption amounts are much lower than the federal threshold. For example, exemptions are just $1 million in Oregon.
It’s quite uncommon for any estate to be taxed. If you are one of the few Americans to leave a large enough estate for taxes to apply, however, it’s important to understand how your estate tax will be calculated. Specifically, with regard to TOD beneficiaries, it’s critical to understand that your probate estate and your 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.
This means that although naming a TOD beneficiary on a CD account will keep the account out of probate, it won’t help you to avoid estate tax. Your CD will count toward the total value of your estate whether you’ve named a TOD beneficiary or not, and your heirs will be liable to pay this tax.
The vast majority of estates aren’t large enough to attract federal estate tax, and only a few states have their own estate taxes. Assets held in a CD—whether with a TOD beneficiary named or not—count toward tax thresholds.
Inheriting a CD
The rules outlined in the previous section mean that very few heirs have to pay estate tax, whether on their CDs or any other assets. However, there are tax consequences associated with inheriting a CD.
Generally, the interest earned by a CD prior to the account owner’s death is not taxable to the beneficiary, nor is the original amount that was deposited. But any interest earned after the account owner’s death would be taxable for beneficiaries. If you inherit a five- or six-figure CD, you might owe a significant amount of tax. If the amount of money in the CD is modest, the tax bill is likely to be modest as well.
This rule applies whether an heir inherits a CD as a TOD beneficiary, as a co-owner, or through probate. In other words, while naming a TOD beneficiary can be a great way to simplify inheritance proceedings, it doesn’t confer any tax benefit on your heirs—whether for estate taxes or income taxes.
What Are the Thresholds for Estate Tax?
As of 2023, federal estate tax only applies only if the assets of the deceased person are worth $12.92 million or more—thus, it only applies to a small number of people. For the calendar year 2024, the threshold is $13.61 million. Twelve states and the District of Columbia have estate taxes, and some of their exemption amounts are much lower than the federal threshold.
Who Can I Name As a Transfer-on-Death (TOD) Beneficiary?
Practically anyone. A transfer-on-death (TOD) beneficiary can be a person, charity, business, or trust. If the beneficiary is a person, they can be a relative, child, spouse, friend, or anyone else whom you happen to know. However, if you are married, your spouse may have special rights over your assets that take precedence over your named TOD beneficiaries.
Does Naming a TOD Beneficiary Have Tax Benefits?
No. While naming a TOD beneficiary can help your heirs avoid the probate process, it doesn’t confer any tax benefit. It doesn’t help you to avoid estate taxes, and your heirs will still have to pay income tax on the earnings of a certificate of deposit (CD) after you pass away.
The Bottom Line
Naming TOD beneficiaries on your CD accounts can help some of your assets avoid probate, because the assets in your CDs will pass to your named TOD beneficiary without having to go through probate. However, this will not help you (or your heirs) to avoid estate taxes, because the value of your CDs counts toward federal and state estate tax thresholds even if they don’t have to go through probate.
The federal threshold for estate taxes is high, and few states impose this tax. In other words, the vast majority of estates don’t have to pay estate taxes.
