Inheritance – no matter the size – can have a substantial impact on you and your family’s financial status. According to a 2015 HSBC survey, American retirees expect to leave an average of $177,000 to their heirs. What should you do when you receive an inheritance?
If you receive an inheritance, in most cases, you don’t have to make major decisions right away. The first step is to do nothing. Take time to mourn and when you’re ready, focus on developing a plan. Understanding what you are receiving as part of the inheritance helps inform how you might incorporate the asset(s) into your own financial plans. Following are some of the more common assets you may inherit and considerations for each.
Retirement Accounts: An IRA or 401(k) are typically tax-deferred accounts and generally haven’t had tax paid so any distributions are taxed as ordinary income. Effective January 2020, non-spouse beneficiaries are now required to distribute retirement accounts within 10 years instead of over their life expectancy which can mean a greater tax impact if no tax planning is done. Roth IRAs are also included in this new rule, although distributions are generally tax-free.*
Real Estate: There are several factors to consider when deciding whether to keep or sell an inherited real estate asset. Are there capital gains or did you receive a step up in cost basis? Will the maintenance and cost to maintain it be a burden? Is it out of state or nearby? Does it have rental potential? Is there a regular or reverse mortgage on it? If left to more than one person, is it someone you want to co-own property with?
Invested Assets: Stock, bonds, mutual funds, etc. held outside of a retirement account are typically tax favorable assets to inherit because there is a step up in cost basis which allows for the assets to be sold with minimal tax impact. Even if there is gain, it’s taxed at long-term capital gain rates.*
Annuity: Is it an IRA or non-qualified annuity? An IRA or other form of retirement account will be fully taxable. If it’s a non-qualified annuity, the gain above what was originally invested in the policy will be taxable, with the return of principal being non-taxable. Some annuities sold within the last 10 years have features that provide additional benefits such as continued guaranteed income, higher death benefits, or possibly restricted payout features. Additionally, some companies allow beneficiaries to make withdrawal decisions independent of each other while others require paperwork to be submitted at the same time. There are several details to research before taking a distribution from an annuity.
Life Insurance: Typically, life insurance is paid tax-free to beneficiaries.
Before deciding what you might do with an inheritance, it’s important to find out what type of assets your inheritance will consist of so you can make informed decisions. Once you know what assets you’re inheriting, then you can think about how you might allocate it.
Here’s an article Kim Baker wrote on What Should You Do With Your Inheritance? https://johnsonbixby.com/what-should-you-do-with-your-inheritance/
Let your planner know if you are expecting or have received an inheritance so we can help you determine what makes sense for your individual situation.
* State and local tax rules may differ.
This material is intended to provide general financial education and is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.