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Being the beneficiary of an inheritance can be very simple to very over-whelming. Each case is different from another. Also, this can come at a time when you are still grieving and processing, an estate may add significant stress and pressure at the wrong time.
Our advisors are here to help you. We have a process for those receiving an inheritance. Following this process may help you ensure you don’t miss anything, as well give you the confidence that it is all being handled correctly.
Don’t Stress and Take Your Time
There are so many emotions typically going through a person who is first starting this process. In some cases, by the time an executor or trustee gets to the estate, you have had the chance to work through many of those emotions. In some cases, people don’t have time to wait and it is thrown upon them. We constantly advise clients to separate emotions from financial decisions. This can be especially difficult in these times. The one thing we can assure you is the process of receiving and investing an inheritance is easier than you might think. Try your best not to stress if you find yourself worrying over theses financial decisions. We are here to help, even if it is just this article.
There are two major types of inheritance: those who are told what and how much they will receive and those who have to figure out what and how much they and others will receive. For the first group, taking an inventory is much easier but may still really help. For the second group, it can be easy to jump right into the process and miss things, due to a tunnel vision with inheritance. This is why we always recommend listing out all assets you expect to receive. Then pause and move to step three before doing anything else.
Consult Your Financial Advisor
Inheritance can be received in many different forms: cash, investment accounts, property, etc. Each form of inheritance comes with its own intricacies. A comprehensive financial advisor can help guide you through the complexities and provide strategies to overcome any unintended consequence for each form of inheritance received.
There is a huge difference between a beneficiary IRA or an IRA. There are specific rules for Roth IRAs that are inherited, which are different than traditional IRAs. The IRS require IRA owners at certain times or ages to take a minimum distribution and pay taxes on the income. This is called a Required Minimum Distribution (RMD). Establishing the accounts the right way may eliminate the need to take a RMD. Also, if you are a spouse who inherits money before either of you turned 59 ½, there are methods to ensure you can withdraw money to pay bills without paying the early withdrawal penalty. The tax implications may be significant if not established correctly.
When someone passes without a trust, there is a step up in the value of assets not in tax deferred accounts. Take your home for example. At a high level, typically your cost basis is what you pay for a house. If a person purchased a home for $200,000, their cost basis is $200,000. There are some exceptions like home offices and improvements accounted for in taxes. Excluding those exceptions, if they sell it for a net of $500,000, they have a $300,000 gain. However, If the person passes away without selling it and the market value is $500,000 at their passing, then the new cost basis is $500,000 for whomever inherits the house. The beneficiary does not have to pay federal taxes on the $300,000 gain at death. Any future gains and losses will be based on the new $500,000 value. There are even different dates you may be able to use to determine the highest value for step up.
Make sure you understand the importance of separate property accounts once you receive an inheritance if you live in a community property state like Texas. A separate property account is a more affordable than establishing a trust, if your major goal is to ensure those assets aren’t split in a divorce. We recommend every client who lives in a community property state strongly consider a separate property account when they receive an inheritance.
There are many issues like these three examples above that may have significant impacts on the net dollar amount you receive. Consulting with the professionals may save you money before its even yours. We offer more than just investment advice. A financial advisor can help you transition an inheritance in the most advantageous way possible.
Understand Your Life Insurance Payout Options
One error many people make when being the beneficiary of a life insurance policy is to assume lump sum payout is your only choice. It isn’t. There are multiple options available and each have their pros and cons. For example, a lump sum payout can be hard to manage and create creditor or protection issues. Other options include a retained asset account, in which the assets stay in an account with the insurance company and receive interest. You can take the money out whenever you like. This removes the worry about having too much in a bank for FDIC coverage or potential claims from creditors and lawsuits. Another option is getting paid principle plus interest over time. This could be over your life, a period certain like 10 years, or several other options.
You should understand all the options, the benefits and weakness of each, and how it all fits into your long-term goals before making a selection.
Aim then Fire
Instead of firing and then aiming. It can be tempting to run out and buy cars or a swimming pool with inherited money. Maybe you have already saved enough money to reach all your financial goals. If not, list the things you would like to accomplish with your sudden wealth. Work with a financial advisor to establish a financial plan. Make sure you know what might be at risk in the future if you buy that expensive asset today. It is definitely your money and no one should tell you how to spend the inheritance. We just want people to be informed by understanding what is needed to pursue your goals.
Plan your Estate
Sometimes the best time to create an estate plan, other than right now if you don’t have one, is after going through the process of receiving an inheritance. Oftentimes, people either feel that the process went so smooth and they want that for their loved ones or that the process was a major headache and they want to ensure that isn’t the case for their beneficiaries. Too often people put off putting their estate in order, even though it is a major shock to most to learn how easy and cheap it can be to complete.
Don’t put it off, get your estate in order now that you know what to expect.
If you followed this process, you should be informed and confident to move forward. It is better to get your new sudden wealth working for you sooner rather than later, whether that means buying something you want like a car, a business or investing for your financial future. Consider Virtus Wealth Management the team you consult with during this process.