Posted On: JUNE 2022
If you’ve received, or will soon receive, a significant inheritance, it may be tempting to view it as “found money” that can be spent freely. But unless your current financial plan ensures that you’ll comfortably reach all your goals, it’s a good idea to have a plan for managing your newfound wealth.
Time for reflection
Generally, when you receive an inheritance, there’s no need to act quickly. Take some time to reflect on the significance of the inheritance for your financial situation; consult with a team of trusted advisors (including an attorney, accountant, and financial advisor); and carefully review your options.
While you’re planning, park any cash or investments in a bank or brokerage account. If you’re married, consider holding the assets in an account in your name only. An inheritance is usually considered your separate property in the event of a divorce, but it may lose that status if it’s commingled with marital property in a joint account.
What are the net proceeds?
If your loved one’s estate is still being administered, don’t spend your inheritance — or make any financial commitments based on it — until you understand what your net proceeds from the estate will be. Once all fees and taxes are accounted for, the final settlement may be less than you expect.
If you’re receiving your inheritance through a trust, talk to the trustee, familiarize yourself with the trust’s terms, and be sure you understand the timing and amount of distributions and any conditions that must be satisfied to receive them.
Are there tax consequences?
An inheritance generally isn’t subject to income tax, but depending on the types of assets you inherit, they may have an impact on your tax situation going forward. For example, certain income-producing assets — such as real estate, an investment portfolio or a retirement plan — may substantially increase your taxable income or even push you into a higher tax bracket.
If you inherit an IRA or a qualified retirement plan account, such as a 401(k), be sure you understand the rules regarding distribution of those funds. (See “Inheriting a retirement plan” below.)
Depending on the size of the inheritance, it may also have an impact on your estate plan. If it increases the value of your estate to a point where estate taxes become a concern, talk to us about strategies for reducing those taxes and preserving as much wealth as possible for your heirs.
Do you need additional insurance coverage?
After receiving a large inheritance, you may need to adjust your insurance coverage. For example, if you inherit real estate or valuable personal property, you may need to increase your property and casualty coverage.
In addition, because greater wealth makes you a more attractive target for lawsuits, you should consider purchasing an umbrella liability policy or increasing the coverage of an existing policy. You may also wish to purchase additional life insurance.
Will inherited assets affect your financial plan?
Treating an inheritance separately from your other assets may encourage impulsive, unplanned spending. A better approach is to integrate inherited assets into your overall financial plan.
Consider using some of the inheritance to pay down credit cards or other high-interest debt or to build an emergency fund. The rest should be available, along with your other assets, for funding your retirement, college expenses for your children, travel or other financial goals.
Have a plan
If you receive a sizable inheritance, there’s nothing wrong with taking a small portion of it and splurging a bit. But for the most part, you should treat inherited assets as you’d treat the assets you’ve earned over the years and incorporate them into a comprehensive financial plan. You’ll also want to address any inherited assets in your estate plan.
Contact us for more information.
Sidebar: Inheriting a retirement plan
The treatment of an inherited IRA or qualified retirement plan, such as a 401(k), depends in part on your relationship to the deceased. If you inherit an IRA or 401(k) from your spouse, you can usually roll the funds over into your own IRA and allow them to continue growing tax-deferred (or tax-free in the case of a Roth account) until you withdraw the funds in retirement.
At one time, if you inherited an IRA or 401(k) from someone other than your spouse, you could “stretch” distributions over your own life expectancy, maximizing the benefits of tax-deferred or tax-free growth. Now, however, under changes made by the SECURE Act, those distributions generally must be completed within 10 years, with a few exceptions.
For example, if you’re less than 10 years younger than the deceased, you can still stretch the distributions over your life expectancy. There are also exceptions for minor children and people who are disabled or chronically ill.
If you inherit an IRA or retirement plan subject to the 10-year payout rule, talk to us about the best strategy for distributing the funds. Depending on the type of plan and your financial circumstances, it may make sense (and be possible under the regulations) to withdraw the funds in equal installments over 10 years, to keep the funds in the account as long as possible or to make irregular withdrawals over the 10-year period to minimize the tax impact.