Five States That Tax an Inherited IRA Differently Than the Original Owner Did
When you inherit an IRA, you may owe state taxes that the original owner never paid. The original owner deferred taxes for decades, but the heir may face a surprise state tax bill the first year they take a distribution. Federal rules allow beneficiaries to stretch withdrawals or take a lump sum, but state tax codes do not always follow the same playbook. In five states, the tax treatment of an inherited IRA diverges sharply from what the original owner paid—or expected.
This article examines those five states, the mechanisms behind the tax, and what the costs look like in dollar terms. The focus is on the price tag and who collects it, not on personalized advice. Every situation is different, and a CPA familiar with multi-state estate returns is essential for anyone facing these rules.
Why Inheriting an IRA Can Trigger a Surprise State Tax Bill
The core of the problem is that the original owner of a traditional IRA never paid income tax on the contributions or the growth. The IRS allows the account to grow tax-deferred, and the owner pays tax only when they withdraw money. When the owner dies, the beneficiary inherits the account and must pay federal income tax on distributions. Most states conform to federal rules and tax those distributions as ordinary income. But five states either add an extra layer of tax or treat the inherited account as something entirely different from what the original owner experienced.
The surprise often comes from the fact that the heir's state of residence, not the decedent's, determines the tax treatment. A New Jersey resident inheriting an IRA from an aunt in Florida may owe New Jersey income tax on every dollar withdrawn, even though Florida has no income tax at all. Conversely, a Florida resident inheriting from a New Jersey aunt would owe nothing to New Jersey on the IRA itself (though the estate might owe inheritance tax before distribution).
The cost range is wide: from zero in states with no income tax to an effective rate approaching 13% in New Jersey for some heirs. No federal estate tax exemption shields the state-level levy, and the Tax Cuts and Jobs Act of 2017 eliminated the stretch IRA for most non-spouse beneficiaries, meaning the entire account must be distributed within ten years. That compressed timeline can push the heir into a higher state tax bracket in the year of withdrawal.
For someone who inherits a US$200,000 IRA, the state tax bill could be as low as zero in Texas or as high as roughly US$26,000 for a New Jersey resident inheriting from a sibling and taking a lump sum. The difference is not trivial, and it is one of the most overlooked costs in estate planning.
Iowa: Full Taxation From the First Dollar
Iowa is one of the few states that taxes inherited IRA distributions as ordinary income with no special deduction for retirement accounts. The state's progressive income tax rates range from 0.33% to roughly 8.5% as of late 2024. Every dollar withdrawn from an inherited IRA is added to the beneficiary's other income and taxed at their marginal rate. There is no exemption for spousal beneficiaries beyond what federal law provides—spouses can treat the IRA as their own, but distributions are still taxable.
For a traditional IRA, this means the heir pays state income tax on every distribution, year after year, until the account is empty. Roth IRAs are not exempt either: while the original owner paid tax on contributions, Iowa does not recognize the Roth's tax-free status on inherited accounts. The state treats a Roth distribution as taxable income unless the account has been held for five years and the owner is over 59½—conditions that cannot be met by a beneficiary who inherits before those thresholds. In practice, virtually all inherited Roth IRA distributions are fully taxable in Iowa.
The practical impact is that an Iowa heir who inherits a US$100,000 traditional IRA and takes a lump-sum withdrawal in a year when they earn US$50,000 from work will owe roughly US$5,500 in state income tax on that IRA distribution alone. If they stretch the distributions over ten years, the annual tax bill is smaller, but the total over the decade is similar because the bracket may rise with other income. For a Roth IRA of the same size, the tax bill would be identical, despite the federal tax-free treatment.
Iowa's tax code has no special provision for inherited retirement accounts. The state's Department of Revenue treats them as ordinary income, period. That is a stark contrast to the original owner, who might have been in a lower bracket during retirement and paid little or no state tax on their own distributions. The heir, often in their peak earning years, pays more.
Nebraska: The Highest Top Rate on Inherited Retirement Assets
Nebraska uses a progressive income tax with a top marginal rate of roughly 6.8% as of 2024. That rate is not the highest in the country, but the state's treatment of inherited IRAs is unusually aggressive. Nebraska taxes the distribution as ordinary income with no step-up in basis for retirement accounts. The heir's federal adjusted gross income includes the IRA distribution, and Nebraska uses that figure as its starting point, so the state tax is calculated on the full amount.
For non-spouse beneficiaries, the tax is due in the year the distribution is taken. If the heir takes a lump sum, the entire account value is added to their income in a single year, potentially pushing them into the top bracket. A US$300,000 inherited IRA could generate a state tax bill of roughly US$20,400 on top of federal income tax. That is a significant cost that many heirs do not anticipate.
Nebraska does not offer a special exemption for small accounts. A US$5,000 inherited IRA is fully taxable at the heir's marginal rate. The state also does not allow a credit for federal estate tax paid, even though the estate may have paid federal tax on the same assets before distribution. This double layer of taxation is one reason some estate planners advise clients to convert traditional IRAs to Roth accounts while alive, if they expect beneficiaries to live in high-tax states.
The state revenue from this tax is not trivial. Some estimates suggest Nebraska collects roughly US$15–20 million annually from the taxation of inherited retirement accounts. That is a small fraction of the state's total income tax revenue, but it is a meaningful sum that policymakers have shown no interest in forgoing. The tax is baked into the code, and changes would require legislative action.
Pennsylvania: Inheritance Tax Applies Even to IRAs
Pennsylvania is unique among the five states because it imposes an inheritance tax on the value of the IRA at the time of the owner's death, not an income tax on the distributions. The inheritance tax rate for non-spouse heirs is 4.5% on the account balance. This tax is due within nine months of the owner's death, regardless of whether the heir takes any distributions. If the heir misses the deadline, the state adds interest and penalties.
The tax applies to both traditional and Roth IRAs. For a Roth IRA, the original owner paid tax on contributions, and the federal government allows tax-free withdrawals for beneficiaries. But Pennsylvania does not recognize that exemption for inheritance tax purposes. The state treats the Roth IRA as an asset subject to the same 4.5% levy as a traditional IRA. That means a US$500,000 Roth IRA inherited by a child triggers a US$22,500 inheritance tax bill, even though the child will never pay federal income tax on the distributions.
Spousal beneficiaries are exempt from the inheritance tax in Pennsylvania, as are transfers to parents, grandparents, and certain other lineal ancestors. But siblings, nieces, nephews, and non-relatives face the 4.5% rate. The tax is due on the full account value, not just the growth. That is a key difference from income tax treatment, which applies only to the amount withdrawn.
Heirs can pay the inheritance tax out of pocket or request a distribution from the IRA to cover the tax. But taking a distribution from a traditional IRA to pay the inheritance tax creates a federal income tax liability, which can then create a state income tax liability in Pennsylvania (if the heir is a resident). That cascading effect can push the effective rate well above 4.5%. For example, a US$100,000 IRA inherited by a sibling would require a US$4,500 inheritance tax payment. If the sibling takes a distribution of US$4,500 from the IRA to cover that tax, they would owe federal income tax on that distribution (assuming a 22% bracket, that's US$990) and Pennsylvania state income tax (at roughly 3.07%, that's US$138). The total cost becomes US$5,628, an effective rate of 5.6% on the original account value.
New Jersey: Both Income and Inheritance Tax Can Hit
New Jersey is the most punishing state for inherited IRAs because it can impose both an income tax on distributions and an inheritance tax on the account value, depending on the relationship between the heir and the decedent. The state's income tax rates go up to roughly 10.75% for high earners, and IRA distributions are taxed as ordinary income. For a non-spouse beneficiary who is in the top bracket, a US$400,000 inherited traditional IRA could generate a state income tax bill of roughly US$43,000 if taken in a lump sum.
On top of that, New Jersey's inheritance tax applies to transfers to non-direct descendants. Siblings, nieces, nephews, and unrelated beneficiaries face a rate of 15–16% on the account value, depending on the amount. That inheritance tax is due before the IRA is distributed to the heir. The estate must pay it, and the estate often requests a distribution from the IRA to generate the cash, which then triggers income tax on that distribution. The combined effective rate can reach 20–25% for some heirs.
Spouses and direct descendants (children, grandchildren) are exempt from the inheritance tax, but they still pay income tax on distributions. For a child inheriting a traditional IRA, the effective state tax rate is the income tax rate, which could be as high as 10.75%. That is still higher than the top rates in Iowa, Nebraska, and Kentucky.
New Jersey does not allow a state-level exemption for inherited Roth earnings. A Roth IRA inherited by a sibling is subject to both the inheritance tax (15–16%) and, because the sibling takes distributions to pay that tax, the income tax on the distribution (since Roth earnings are not tax-free to non-spouse beneficiaries in New Jersey). The result is a tax bill that many families underestimate by a wide margin. For a US$200,000 Roth IRA inherited by a sibling, the inheritance tax would be roughly US$30,000 (at 15%). To pay that, the sibling might take a distribution of US$30,000, which would be subject to New Jersey income tax at their marginal rate (say 6.37% for a middle-income earner, costing US$1,911). The total state tax bill would be US$31,911, or nearly 16% of the account value.
Kentucky: A Flat Rate That Catches Many Off Guard
Kentucky taxes inherited IRA distributions as ordinary income at a flat rate of roughly 5% as of 2024. The rate is not progressive, so every dollar withdrawn from the inherited account is taxed at the same percentage, regardless of the heir's other income. That simplicity is deceptive because the tax applies to the full distribution amount, and there is no special exemption for retirement accounts.
The flat rate means that a US$50,000 distribution triggers a US$2,500 state tax bill. For a US$200,000 account stretched over ten years, the annual tax is roughly US$1,000, which adds up to US$10,000 in total. That is not trivial, but it is lower than what the same account would generate in New Jersey or Nebraska for a high-earning heir.
Kentucky does not distinguish between traditional and Roth IRAs. A Roth distribution is fully taxable at the 5% rate, even though the original owner paid tax on the contributions. The state's reasoning is that the account was never subject to Kentucky income tax during the owner's lifetime, so the state wants its share when the account passes to a new taxpayer. That logic applies regardless of the federal tax treatment.
Heirs must file a Kentucky state income tax return even if they have no other income from the state. The IRA distribution is considered Kentucky-sourced income if the decedent was a Kentucky resident at the time of death. That filing requirement often catches out-of-state heirs who assume they owe nothing to Kentucky. The state will pursue collection if the return is not filed, and penalties can add up quickly. For example, an heir living in Texas who inherits a US$100,000 IRA from a Kentucky resident would need to file a Kentucky non-resident return and pay US$5,000 in state tax, plus any late-filing penalties if they miss the deadline.
How to Plan Around These Tax Traps
The most effective strategy is to check the beneficiary's state tax rules before the original owner dies. If the owner lives in a state with no income tax but the beneficiary lives in one of the five states discussed here, the owner might consider a Roth conversion while alive. Paying tax at the owner's lower rate (or zero rate) can save the beneficiary a larger tax bill later. The conversion triggers income tax in the year it is done, but if the owner has other deductions or a low income year, the cost may be manageable.
Trust planning can also shift the tax burden, but it is highly complex and requires careful drafting. A common approach is to name a trust as beneficiary of the IRA and have the trust distribute the income to the beneficiary each year, allowing the beneficiary to pay tax at their own rate. However, trust tax brackets are compressed, and the interaction with state tax laws varies. Because the rules differ significantly by state, professional advice is essential before implementing any trust-based strategy.
Lump-sum withdrawal is almost always the worst option in these five states, because the entire account value is taxed in a single year at the heir's highest marginal rate. Stretching distributions over the ten-year period allowed by the SECURE Act can smooth the tax burden, but it does not eliminate it. In Pennsylvania, the inheritance tax is due within nine months regardless of the distribution schedule, so the heir must have cash available from other sources or take an early distribution that generates income tax.
Another option is to disclaim the inheritance. If the beneficiary is in a high-tax state and the contingent beneficiary is in a no-tax state, the primary beneficiary can refuse the IRA, and it passes to the next in line. That is a drastic step, but it can save thousands of dollars in state tax. The disclaimer must be made within nine months of the owner's death and before the beneficiary accepts any benefits from the account.
Each strategy has costs and benefits; professional advice is essential. A CPA who handles multi-state estate returns can run projections for different distribution scenarios and help the heir choose the least-taxed path. The cost of a mistake can be high, so investing in expert guidance is often worthwhile.
This article is for informational purposes only and does not constitute personalized tax or legal advice. Tax laws are subject to change, and individual circumstances vary. Consult a qualified professional before making decisions about inherited retirement accounts.
