Epigenetic modifications have effects on phenotype, but they are generally considered to be cleared on passage through the germ line in mammals, so that only genetic traits are inherited. Here we describe the inheritance of an epigenetic modification at the agouti locus in mice. In viable yellow ( A(vy)/a) mice, transcription originating in an intra-cisternal A particle (IAP) retrotransposon inserted upstream of the agouti gene (A) causes ectopic expression of agouti protein, resulting in yellow fur, obesity, diabetes and increased susceptibility to tumours. The pleiotropic effects of ectopic agouti expression are presumably due to effects of the paracrine signal on other tissues. Avy mice display variable expressivity because they are epigenetic mosaics for activity of the retrotransposon: isogenic Avy mice have coats that vary in a continuous spectrum from full yellow, through variegated yellow/agouti, to full agouti (pseudoagouti). The distribution of phenotypes among offspring is related to the phenotype of the dam; when an A(vy) dam has the agouti phenotype, her offspring are more likely to be agouti. We demonstrate here that this maternal epigenetic effect is not the result of a maternally contributed environment. Rather, our data show that it results from incomplete erasure of an epigenetic modification when a silenced Avy allele is passed through the female germ line, with consequent inheritance of the epigenetic modification. Because retrotransposons are abundant in mammalian genomes, this type of inheritance may be common.