Inheriting money or other assets is both a blessing and a responsibility. Handled wisely it can open doors and create opportunities not possible otherwise.
As with most large money decisions, it's best to move slowly when coming into an inheritance. You'd think that most individuals who inherit significant wealth end up better off - but too often that is not the case. Money and assets get squandered through poor decision making, bad tax planning, or impulsive behaviors.
In this guide we will share our thoughts on how to handle an inheritance should you have recently received one or anticipate one in the future.
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Inheriting money can be both difficult and exciting. It’s important to make sure you give yourself adequate space and time for mourning before making any financial decisions.
Moving too quickly without thoroughly processing your emotions may lead to potentially reckless choices or impulsive decisions.
If you had not already given deep thought to what you might do with a sudden blessing of money, that's a good sign to take some deep breaths, pause, and consider - what might I like to do with this money or these assets?
Carrying out the exercise of considering your wants does not mean you need to commit to executing on those wants.
However, getting the desires out of your head and onto paper, or speaking them out verbally will help you truly evaluate whether you REALLY value that thing (or experience), or whether it’s just FOMO (fear of missing out).
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Handling an inheritance can be overwhelming both psychologically and financially.
Yes - it can be complicated to come up with a financial plan that honors the legacy of those you inherited the funds from. But you may also have psychological blocks or even guilt.
If it's an inheritance from parents, you may have thoughts about what they "expect" you to do with those funds.
This can be particularly true with inherited property. Do you keep it in the family? Do you sell it? What if you have siblings who are now partners with you in a property? What if one sibling wants to sell while the others prefer to keep the property?
All these types of questions will come up. For this reason, we recommend getting together a team of professionals who can support you through this process that may include:
You don't need these professionals to give you instructions about what to do with your inheritance.
Rather, they should be retained to educate and teach you so that you can wisely choose among the options that will come your way with this new wealth.
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As you retain professional guidance, it can be useful to find a temporary and secure location to store your inheritance if it's in cash.
Deposit it into a High Yield Savings Account such as those offered by Ally Bank or Synchrony Bank.
High Yield Savings Accounts are FDIC (Federal deposit insurance corporation) insured up to $250,000 for individuals and $500,000 for couples. If you've inherited more than the FDIC limit, you can open an account at multiple institutions to increase your coverage, as the coverage limits are on an institution by institution basis.
A second option to temporarily park cash would be in a money market fund (MMF). MMF's can be accessed via brokerage accounts through large brokers such as Charles Schwab or Fidelity.
Brokerage accounts and MMF's are SIPC insured up to $250,000 for cash, or up to $500,000 for cash and invested securities.
At Charles Schwab, a useful MMF ticker is SWVXX.
At Fidelity, the MMF ticker is SPRXX.
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Cash can go any combination of three ways.
Planning for your cash inheritance involves finding the right balance of the three.
If you do not already have one in place, coming into a cash inheritance can be a great catalyst to work with a fee only fiduciary financial advisor or financial planner to put a financial plan in place.
Working backwards from your financial plan will help outline whether (and how much) of that cash inheritance should be applied to:
Determining the right combination and application of the above choices is more an art than a science.
You are a unique individual with unique preferences, concerns, and behaviors.
Having a relationship with a fee only fiduciary financial advisor who understands how you think and feel about money can help you document and prioritize the above list.
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What if the inheritance is not cash, or only partly in cash?
Inherited retirement accounts, brokerage accounts, property, or businesses will have consequences that must be planned for.
It is important to have a strategy in place for addressing tax related issues. It will likewise be critical to verify that ownership of the respective assets can be successfully transferred while maintaining maximum value.
This is where who you choose to be a part of your financial support team has a large impact.
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When it comes to handling inherited real estate, there are generally three possibilities: sell the property, rent the property, or live in the property.
In most cases, inherited property will be worth more than it was originally purchased for.
Inherited homes receive what is called "a stepped up tax basis".
This reduces the tax burden heirs will face if they need to sell the property. As an example:
Say you inherited a home from deceased parents. They purchased the house for $125,000. At the point at which you inherit it, the home is valued at $350,000. That $350,000 value becomes the "price tag", or your "cost basis" in the property. Now say you sell the property a year later for $400,000. You would only be taxed on the $50,000 difference between the $350,000 value at the time of inheritance and the $400,000 value at the time of sale due to this step up in basis.
A thorough evaluation should be performed to determine if renting the property out will be a good option.
It's important to compare the rate of return against other comparable investments. But not only that, you must also consider the fact that you will now be a landlord, with all the responsibility and headache that may entail.
Let's use an example to address the financial side of this evaluation.
Say the home is valued at $400,000. Assume you can rent it for $1625 per month, or $19,500 per year.
Now you need to consider the expenses of owning and maintaining the home.
Let's assume property taxes of $4,000 per year, maintenance of $2,500 per year, and a vacancy factor of 5%, or $975 per year.
The total expenses would be roughly $7425 per year.
Your NET rental income from the property would be the $19,500 in rent collected less the $7,425 in expenses, resulting in $12,075.
That $12,075 in income represents a 3.02% rate of return on the home as an investment property ($12,075 divided by the home value of $400,000).
Now you'd have to consider whether it makes sense to be a landlord, hold onto a depreciating asset, with all that equity locked up inside it for a 3.02% rate of return.
In this hypothetical situation, I would most likely not recommend renting out the property for that kind of rate of return.
This exercise is not to say it is never a wise decision - only to illustrate how it should be evaluated - you must consider the financial reward while also considering the financial AND non financial costs that are associated with it.
Inheriting a paid off home can be a great blessing. No housing payment!
Just remember that there are carrying costs associated with home ownership.
You'll still need to account for property taxes, maintenance, large one time repairs (think roof, pipes, etc).
If you don't already have an emergency fund or a significant cash holding, living in the property may not actually be the best option despite the fact that you'll have no rent/mortgage payment.
Having all your wealth locked up in the home may actually be detrimental because you cannot access it even though on paper you do have this wealth.
It's important to consider that - access to the wealth - as a part of the calculus when deciding whether to sell, rent, or live in the inherited home.
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Inherited investments will usually come in 2 forms.
Retirement accounts, or brokerage accounts.
Each will have its own set of concerns to evaluate.
The most immediate of which will be tax concerns.
Inherited Traditional IRA and 401(k) accounts require that heirs empty those accounts within 10 years of inheriting them. This can cause large tax burdens on the heirs when not planned for appropriately.
Generally speaking, tax deferred investment accounts are the least advantageous form of inherited investment money.
ROTH IRA and ROTH 401k accounts do not have this same restriction.
There are no required minimum distributions or required distribution timelines for these account types, making them much more attractive as inheritance options.
Finally, taxable investment accounts (brokerage accounts) will receive a step up in cost basis similar to inherited property.
This can be very beneficial to heirs and falls somewhere in between tax deferred and ROTH accounts.
Working with a fee only fiduciary financial advisor can help you stay informed and ahead of the tax consequences of how legacy assets are positioned. It's best to plan ahead for these matters while alive.
In addition to tax concerns, you will also have some education and planning to consider regarding the actual investment makeup of the funds within the accounts.
Knowing whether the funds are invested in stocks, bonds, mutual funds, exchange traded funds, or some combination will be critical.
You'll also need to consider whether to change that allocation, how to change it, and what the long term consequences of those changes might be.
We recommend working with a fee only fiduciary financial advisor who is required to give you advice that is in your best interest when considering how to manage inherited investment money.
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Navigating taxes on your inheritance can be intimidating, but understanding the fundamentals is key to making informed decisions. Tax implications of an inheritance vary depending upon the types you may encounter which include: estate tax, capital gains taxes, and income taxes.
Federal estate taxes only apply to estates valued at above $12.92 million (2023). If you are in a position where the estate is subject to estate taxes, we recommend consulting with tax specialist and attorney who specialize in estates of that size. However it can be useful to note that you as the heir are not on the hook for estate taxes - the estate itself is.
Inheritance taxes are imposed after a loved ones estate has been disbursed.
There is no federal inheritance tax.
However, six states do apply an inheritance tax: Iowa, Nebraska, Pennsylvania, New Jersey, Maryland and Kentucky.
Exemptions may apply in certain cases, such as when recipients are spouses, children and grandchildren, along with other dependents.
Taxes are complicated. They are overwhelming.
And they will punish you for actions done incorrectly.
Despite our outlining many of the tax considerations above, we highly recommend working with a qualified professional rather than trying to navigate the tax consequences of your inheritance on your own.
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Most of us will be lucky to inherit anything of significant value in our lifetime.
That being said - managing an inheritance is not a circumstance where you should be trying your hand at a whole bunch of new things for the first time.
When it comes to money and wealth, there are no do overs!
Costly mistakes incorrectly rolling over funds, or incorrectly distributing a retirement account can have permanent and costly consequences.
Interview, qualify, and find a fee only fiduciary financial advisor that you can trust to help you along this journey.
Any advisor who encourages quick moves with inherited funds should be written off immediately.
A financial plan or retirement plan should be a prerequisite before any significant money movements or changes to investment strategies are made.
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Navigating your inheritance can be both complex and a deep emotional experience.
It’s important to take the time to process grief and evaluate your most prudent options.
Be sure to build a financial team for support who can help you consider which goals are most important to you.
Finally, be certain to understand the tax consequences of inherited cash or assets - remember - decisions cannot be un done!
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When you are the lucky recipient of an inheritance, it is important to explore your options so that you make wise decisions. An emergency fund should be built up in case any unexpected costs arise. You could also look into a high-yield savings account where funds will accrue interest with time. Beyond that, seek professional advice to determine the right investment strategy and financial plan for you.
It depends on the circumstances! If the inheritance feels large to you, then it is a large inheritance! This kind of generous bequest is a huge blessing that can be applied to your retirement savings or help pay down a home. Seek professional advice if the inheritance feels large and you don't already have a sound financial plan in place.
Inheritance money typically does not need to be reported to the IRS, since it is not considered taxable income by the federal government.
High yield savings accounts and money market funds are safe temporary locations to house your inheritance money.
Work with a fee only fiduciary financial advisor to create a better long term investment plan for your inheritance.
Remember - you do not get financial “do - overs” - so move slowly and get qualified advice before making any permanent decisions with these new funds.
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