An inheritance is just one aspect of what can be a very emotional time period. It may be helpful to know what happens when you inherit money or assets. Here are 7 ways to prepare.
1. Don’t expect it
The old adage, “Don’t count your chickens before they’ve hatched,” rings true when it comes to inheritance.
If you’re expecting an inheritance, perhaps the best thing you can do is not expect it.
It is difficult to bank a potential inheritance. There is a lot that can happen to a loved one who leaves you something and their will may not come to fruition. Many potential heirs anticipate an inheritance only to find that medical costs, extended life, or long-term care needs have eroded the donor’s estate. (Note: Long-term care is a serious cost concern as people age.)
However, recently reconnaissance It found that one in three Americans not only expect an inheritance, but also depend on it to stabilize their financial situation. Those expectations do not match reality.
Catherine had the right attitude when she wrote: “I anticipate that I will inherit some money and property from my mother (I know her will and estate plan) but I am not factoring that into my plans yet because she will likely have a better life.” It takes a long time and may require a lot of care. “It’s her money and she worked hard for it, so I don’t think it’s mine.”
2. Be prepared to wait
Unless your donor has a good estate plan, you may need to wait months (sometimes years if the estate is discovered in the will) to receive funds from the inheritance.
3. What happens when you inherit money? Taxes!
In most states, estate taxes are only a problem for the wealthy. However, there are other types of tax implications for many inheritances. Notably, inheritance can result in capital gains, income and property taxes. Its amount and maturity date often depend on the type of asset you receive.
Below is a very simplified view of the tax treatment of different types of assets.
If you receive an inheritance, it may be important for you to calculate the after-tax value of the windfall. Don’t think of the total value as yours, just what you have access to after paying taxes.
Taxable accounts
There are significant advantages regarding capital gains taxes when you inherit a taxable account. These accounts benefit from a tax break known as “basis step-up.” The baseline is the starting line against which taxes are calculated. An increase in basis basically means that the starting line has been moved from the time the deceased invested the money to the time he died.
Example: Let’s say your aunt bequeathed you a taxable account. Fifty years ago, she invested $25,000 and, through smart investing, the account was worth $100,000 on the day she died. Her cost basis was $25,000, so if she lived and liquidated the account on the date of her death, she would need to pay taxes on the $75,000 gain.
However, I left the account to you. As such, the estimated asset value for tax purposes is readjusted to the account value on the day of death. From now on, you will only pay taxes on gains you earn over $100,000
Traditional retirement accounts
If you inherit a retirement account such as an inherited IRA, you will have to pay taxes on the amount you inherit, but you have options to reduce the tax impact.
If you inherit money from your spouse, you can roll the money over to your IRA and defer withdrawals and tax until you turn 72.
If you inherit the account from someone else, and want to maintain tax efficiency, you can roll the money over to an inherited IRA. From there, you must take required minimum distributions (as defined by the IRS) each year and pay taxes on the money you withdraw. You are allowed to withdraw as much as you want, but all distributions will be taxed.
Roth IRA
So, what happens if you inherit money in a Roth IRA?
If it is a Roth IRA inherited from your spouse and you are the sole beneficiary, you can treat the account as your own.
Other types of beneficiaries have different options for receiving the money, each with their own tax advantages and disadvantages. It may be best to consult a financial advisor to get the best option for you.
Real estate
Like inherited taxable accounts, estates are stepped up to the value of the property on the date of the owner’s death. Let’s say you inherited a home that was originally purchased for $100,000 and is currently valued at $250,000. If you sell the home sometime after the original owner’s death for $275,000, in this scenario, you will only pay capital gains taxes on the amount that has appreciated in value since you inherited it by $25,000.
However, the increased value also has estate tax implications. During the five years between the inheritance and the sale, you will have paid estate taxes based on the increased value of the property.
life insurance
Life insurance is not taxed as income.
4. Be grateful
Many happy extended families have been torn apart by inheritance. Even properties of minimal financial value caused cracks in relationships. I know sisters who won’t talk to each other because of a disagreement about who can get a cheap watch.
Remember tip number one? Don’t expect anything! And if you get something, be grateful no matter what.
It’s not always easy, but gratitude has been proven to be a great balm for living a fulfilled life.
5. Try to talk frankly with the potential donor
Honest conversations with family members can improve expectations and give everyone a better understanding of possibilities.
Most people think that money is silence, but honest talk has tremendous benefits. See tips for discussing finances with your loved ones.
6. Go slow and make a plan to use the money
If you receive a cash inheritance, it can usually be used however you wish. You can pay off debt, splurge, invest, and buy real estate.
However, you may want to consider your options carefully. It may be wise to slow down and make a thoughtful plan to get your money. You may want to use a tool like NewRetirement Planner to run scenarios with different uses for the money and see what different options will do for you.
7. Keep wills to a minimum
What happens when you inherit money? Well, sometimes you attract unwanted attention.
It often seems that people view inherited money in a different category as earned money. Some people have the impression that an inheritance is a windfall that needs to be shared.
However, in the NewRetirement Facebook group, Hook had a potentially helpful tip. “Tell as few people as possible about your inheritance,” he said.
There’s not much good that can come from talking about this kind of windfall. It can create jealousy and conflict.
Run scenarios in your new retirement planner
If there is an opportunity to receive an inheritance or other future lump sum, model that possibility in your new retirement planning. You should also run a scenario when you don’t receive the money. Or see what happens if your inheritance is a fraction of what you expected.
Contingency planning is one of the strengths of the New Retirement Planner. This can help you think about what might happen under a variety of different circumstances. You will gain confidence that you can be safe no matter what.
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