Inheriting a CD can cost you money. Though an inheritance is not generally subject to federal income tax, the interest earned on an inherited CD is. To avoid that, you can close the account and withdraw the funds but the bank may charge an early withdrawal penalty in that case.

The Web site for the Kansas City Star, Kansascity.com, ran a column on Monday penned by Claudia Buck in which a reader asked about the interest earned on an inherited CD.

Here’s what Buck had to say about inheriting a CD in “Ask the experts: Is inherited CD’s interest taxable?”

A certificate of deposit is not taxable to the beneficiary, under the general rule that an inheritance is not subject to federal income tax.

However, the earnings on an inheritance are taxable. The bank will send a 1099-INT when taxable interest paid on an account is at least $10 during the year.

The CD the writer inherited was what is known as a payable-on-death CD, the subject of a recent Dr. Don column on Bankrate.

A payable-on-death, or POD, account allows you to name beneficiaries for the certificate of deposit. POD CDs are often used to avoid probate because the assets transfer when the account owner dies. Savings bonds and some other assets also can have POD beneficiaries.

Unless you want to pay the early withdrawal penalty, you may be stuck with the extra interest income from the inherited CD. Dr. Don reports that banks may use their own discretion in regard to waiving early withdrawal penalties upon the death of a CD account owner.

Have you inherited a CD or had any problems closing an inherited CD account?

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