Inheritance is just one aspect of what can be a very emotional time, and it helps to know what to expect when you inherit money or assets. Here are seven ways you can prepare:
1. Don’t expect too much
The old adage, “Don’t count your eggs before they hatch,” rings true when it comes to inheritance.
If you are expecting an inheritance, it’s probably best not to expect it.
Inheritances are hard to bank. Lots of things can happen to loved ones who are hoping to leave you something, and bequests may never come to fruition. Too many heirs expect to inherit, and then find their benefactor’s assets dwindling due to medical expenses, outliving, or long-term care needs. (Note: long-term care is a serious cost issue as we age.)
However, recent investigation Surveys show that one in three Americans not only expects an inheritance, but also plans to use it to stabilize their financial situation. These expectations don’t line up with reality.
Katherine writes, “I expect to inherit some money and assets from my mother (I am aware of her will and estate plan), but I have not included it in my plans for now because she may live a long time and need a lot of care. It’s my mother’s money and she worked hard for it, so I don’t think of it as my own.” This is a good way of thinking.
2. Be prepared to wait
Unless beneficiaries have done proper estate planning, they may have to wait months (or even years if the estate gets caught up in probate) to receive funds from the estate.
3. What happens when you inherit money? Taxes!
In most states, inheritance taxes are only an issue for the very wealthy. However, many inheritances involve other types of taxes. Most notably, inheritances can trigger capital gains taxes, income taxes, and estate taxes. The amount and timing of these taxes depend on the type of assets you receive.
Below is a very simplified summary of the tax treatment of different types of assets.
If you receive an inheritance, it can be important to calculate the after-tax value of your windfall. Don’t think of the total amount as yours, just the amount you have access to after paying tax.
Taxable Account
Inheriting a taxable account has a significant advantage when it comes to capital gains tax. These accounts benefit from a tax break called basis increase. Basis is the starting line for calculating tax. Basis increase means that the starting line is moved from the time the deceased invested the funds to the time of death.
example: Let’s say your aunt bequeathed you a taxable account. 50 years ago she invested $25,000 and, through wise investing, the account was worth $100,000 on the day she died. Her cost basis would have been $25,000, so if she had been alive and liquidated the account on the day she died, she would have had to pay tax on the gain of $75,000.
But she left you an account, so the value of the appreciated assets will be adjusted to the value of the account on the date of death, and for tax purposes, you will only pay tax on the gain over $100,000.
Traditional Retirement Accounts
If you inherit a retirement account, such as an inherited IRA, you’ll have to pay tax on the amount you inherit, but there are options to minimize the tax impact.
If you inherit assets from your spouse, you can roll them into your own IRA and defer withdrawals and paying taxes on them until you are age 72.
If you inherit an account from someone and want to keep it tax-advantaged, you can transfer the money into an inherited IRA account, from which you’ll need to take required minimum distributions (as defined by the IRS) each year and pay taxes on any money you withdraw. You can withdraw as much as you like, but you’ll be taxed on all distributions.
Roth IRA
So what happens if you inherit money in a Roth IRA?
If the inherited Roth IRA came from your spouse and you are the sole beneficiary, you can treat the account as your own.
Other types of beneficiaries have different ways of receiving your money and each has their own tax advantages and disadvantages, so we recommend speaking to a financial advisor about the best option for you.
real estate
Like inheritance taxable accounts, the value of the property is increased to the value of the property on the date of the owner’s death. So, say you inherit a home that was originally purchased for $100,000 and is now worth $250,000. If you sell the home for $275,000 sometime after the original owner’s death, in this scenario you would only pay capital gains tax on the $25,000 that it has increased in value since you inherited it.
However, the increase in value also impacts your property taxes: in the five years between inheriting it and selling it, you will pay property taxes based on the increase in value of the property.
Life insurance
Life insurance is not taxed as income.
4. Be grateful
Inheritance has torn apart many large, happy families. Even possessions of little monetary value can cause rifts in relationships. I know sisters who stopped speaking to each other after arguing over who got an inexpensive watch.
Remember tip number one? Don’t expect anything, and when you receive something, be grateful for it, whatever it may be.
Although it’s not always easy, gratitude has proven to be a great comfort for living a satisfying life.
5. Try to be open with your prospective donors
Honest conversations with families raise expectations and help everyone better understand the possibilities.
While most people would prefer to keep their finances private, there are big benefits to being honest. Check out our tips for discussing money with your loved ones.
6. Plan your spending slowly
If you receive a financial inheritance, you can usually spend it however you like: pay off debts, splurge, invest, buy property, etc.
However, we recommend that you consider your options carefully. It’s wise to take your time and develop a financial plan carefully. You can also use a tool like the NewRetirement Planner to run different financial scenarios and see how different choices affect you.
7. Keep your bequest a secret
What happens when you inherit money? It can attract unwanted attention.
People often think of inherited money as a separate category from earned money. Some have the impression that inheritances are just extra income that should be shared.
But in the NewRetirement Facebook group, Hook offered some advice that may be useful: “Talk to as few people as possible about your inheritance,” he said.
Not much good will come from talking about these unexpected good fortunes; it may breed jealousy and strife.
Run scenarios in NewRetirement Planner
If you expect to receive an inheritance or a lump sum in the future, model that possibility in the NewRetirement Planner. You should also run scenarios if you never receive the money, or see what would happen if your inheritance was only a fraction of what you expected.
Contingency planning is where NewRetirement Planner shines – it helps you think through what would happen under different circumstances, giving you the confidence that you’ll be secure no matter what.
