Don't Rely on a Large Inheritance

Baby boomers have accumulated significant wealth, in terms of both their home equity and their retirement savings. But if you’re a millennial or Gen Xer, the amount you inherit from your boomer parents may be fairly modest — if you receive anything at all.

That large inheritance may be smaller than you think

A 2020 Federal Reserve analysis found that the average inheritance was $46,200. And even that figure was inflated by legacies passed down in wealthy families, the Fed said. If you’re depending on an inheritance to make up for what you haven’t saved for retirement, think again.

Longer life expectancies

One reason your parents may leave a smaller inheritance than you expect is that their generation is living longer than previous ones. While the average life expectancy in 2021 was 79.1 years for American women and 73.2 years for men, there’s a good chance your parents will live much longer than that because of medical advances that could extend their lives. The number of Americans who are 95 and older grew 48.6% from 2010 to 2020, according to the 2020 Census. For a 65-year-old couple, there’s a 50% chance that one spouse will live to age 93 and a 25% chance that one will live to 97, according to the Society of Actuaries.

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Medical expenses and long-term-care costs could also reduce the amount of money you’ll receive when your parents die. Seven out of 10 people age 65 or older will need some kind of long-term care in their lifetime, and one in five will require care for more than five years, according to the National Center for Health Statistics. The median cost of a semi-private room in a nursing home is $7,908 a month, according to Genworth’s Cost of Care survey. 

Other threats to your parents' savings

Even if your parents don’t require nursing home care, other factors could reduce the size of their nest egg, says Bill Schretter, a certified financial planner with wealth-management firm Allworth Financial. “People’s assets at 60 can be greatly reduced by the time they’re 85,” he says. “Inflation, the stock market going up and down, and even mismanagement of their finances can lead to parents having less money to leave their children.” 

Fraud losses are another concern. As individuals age, they’re increasingly at risk for cognitive decline, which makes them more vulnerable to scams, Schretter says. Older Americans lose more than $28 billion a year because of fraud, according to AARP. 

Debts and taxes

When your parent passes away, the executor of the estate must pay all outstanding taxes and debts before distributing assets to heirs. The executor may also have to pay funeral expenses (unless those costs were paid in advance), along with attorney fees and other fees associated with managing the estate. 

Schretter recommends that you hold on to any valuable items you inherit in case you discover other outstanding debts. You may need to sell those items to pay them off, he explains. 

After the estate’s debts are paid, you may have to pay inheritance taxes, depending on where you live. In contrast to an estate tax, which is paid by the estate, heirs are responsible for paying inheritance taxes. Fortunately, there is no federal inheritance tax. And though most states with an inheritance tax make children of the deceased exempt, Nebraska and Pennsylvania do not. Nebraska’s inheritance tax rate is 1% for children, while Pennsylvania taxes those heirs at a rate of 4.5%.

In addition, if you inherit a parent’s traditional IRA or 401(k) plan, you’ll be required to pay taxes on withdrawals, which could significantly reduce the size of the account. Before 2020, you could lower the tax bill by taking withdrawals based on your life expectancy. But the Setting Every Community Up for Retirement Enhancement Act (known as the SECURE Act), passed in 2019, eliminated that strategy by requiring non-spouse heirs to withdraw all of the funds within 10 years of the original owner’s death. Consider getting professional help to manage the tax bill and avoid any potential penalties, says Erica Parker Ellis, an advanced planning attorney at Hargrove Firm LLP. 

Managing your inheritance

If you do inherit money from your parents, Schretter recommends postponing any major purchases. “When you’re in mourning, don’t make any rash decisions,” he says. Pay off your credit card and other high-interest debt, and then put the money in a savings account until you’ve decided how to make the most of your legacy.

Schretter suggests using some funds from your inheritance to meet with an attorney and set up your own estate plan. A study by Caring.com found that more than two-thirds of Americans don’t have a will, and 40% of those individuals say they plan to wait until they have a serious medical diagnosis to draw one up. In many cases, that’s too late to provide for your loved ones in the event of your death.