Inheritance Issues to Consider

When beneficiaries receive an inheritance, it is important to look at how this money fits into their financial plan. This will depend upon the size of the inheritance and the state of their financial situation.

Regardless of the size of the inheritance, it makes sense to look for areas of your financial situation where the money can be best applied. Depending upon the size and nature of the inheritance, several areas might be addressed with the inheritance. These can include: reducing debt, funding your children’s education, adding funds to your investment portfolio, purchasing something of importance to you, and donating funds to a charitable cause.

The form in which the inheritance is received can vary significantly and may often impact how and when the money can be deployed. If the inheritance is received as cash, this might come from the balance in a bank account or in the form of a life insurance death benefit from a policy in which you were a beneficiary.

Inheritances can also come to heirs as securities such as shares of individual stocks, ETFs, mutual funds, bonds, as well as private investments. They could also take the form of real estate, art and collectibles or an interest in a privately held business.

In the case of publicly traded securities, you may receive a step-up in basis, meaning that your cost basis will be the market value on the date of death, not the deceased’s original cost basis. In the instance of highly appreciated securities, this can save a significant amount in capital gains taxes when you sell the shares.

Many who are inheriting retirement accounts (IRA’s, 401(k)’s, 403(b)’s, etc.) are familiar with how to make contributions, but are not yet knowledgeable about issues with distributing money from them. Your options with managing inherited retirement accounts depend on your relationship to the beneficiary. With the advent of the SECURE Act at the beginning of 2020, the rules surrounding inherited IRA accounts for most non-spousal beneficiaries changed and these beneficiaries are now required to withdraw the entire account balance within a ten-year period. Inheriting an IRA can lead to heavy taxes so knowing your options can save you from penalties for not following mandatory distribution rules.

Depending on the nature of the assets inherited, there may also be tax or liquidity issues to deal with. Inheritances are not protected from taxes.  Factors such as inheritance total, composition, and the state in which you live, will impact whether you may be subject to federal and state taxes.  Estate taxes are levied by the federal government on the total value of an estate before it’s distributed as an inheritance.  Inheritance tax is a state tax, levied by several states.  Depending on your state, and the amount of the inheritance you received, you may be subject to state inheritance tax.

If your inheritance is in the form of a trust, the assets will often be managed by a trustee.  While trustees can be anyone, they’re usually an investment advisor, banker, lawyer, or another family member. The trustee is responsible for managing and distributing the assets held in the trust according to the trust’s language, so you should read the trust so that you fully understand the trustee’s responsibilities.

Real estate can also experience a step-up in basis in some cases as well. Assets like real estate, art, collectibles and others will not be as liquid as publicly traded securities and may require a longer time horizon to sell these assets.

In the case of an interest in a privately held business, how you proceed will depend upon whether you are or would like to be involved in the business or whether you are looking to sell the business interest to other owners of the business or to an outside third party.

Coming into a large inheritance doesn’t guarantee financial security. By developing a financial plan and an estate plan, you may be able to help protect your inheritance.  In addition to preserving your inheritance and wealth, an estate plan seeks to protect your loved ones from excessive taxes, ambiguity, and privacy issues.