Inheriting wealth can be a life-altering event. While it may seem like a straightforward financial boon, it comes with its own set of complexities and emotional nuances. Whether it's a modest sum or a significant estate, managing an inheritance responsibly requires careful thought and planning. Here are three key considerations to keep in mind when you find yourself the beneficiary of inherited wealth.
1. Understand the tax implications.
Taxes can take a significant bite out of inherited wealth. The type of assets you inherit, and the laws of your state can greatly affect the tax consequences. For instance, while life insurance proceeds are typically tax-free, inherited retirement accounts, like an IRA or 401(k), are not and can lead to a hefty tax bill if not managed properly.
In the case of inherited property, you may benefit from a step-up in basis, which can minimize capital gains taxes if you decide to sell. Estate taxes, while only affecting the wealthiest estates, should also be considered.
When wealth changes hands through inheritance, it brings myriad tax considerations that can be bewildering. The types of inheritance, whether they be cash, investments, property, or retirement accounts, come with different tax treatments. Inherited retirement accounts, for example, can be taxed heavily if withdrawals are not handled strategically. Understanding the rules about required minimum distributions (RMDs) is essential to avoid penalties, particularly since the SECURE Act was passed in December 2019.
Real estate inheritances provide a “step-up in basis,” which means the property’s tax basis is updated to its current market value, potentially reducing capital gains taxes if sold. However, navigating this requires an accurate appraisal at the time of the previous owner's death.
Estate taxes, while not applicable to the majority due to high federal exemption limits, can be significant for larger estates. Some states also levy their own estate or inheritance taxes, which can catch beneficiaries off guard.
2. Invest wisely.
With sudden wealth, there's often the temptation to make large purchases or risky investments. Before making any significant financial decisions, take a step back and assess your overall financial picture. This could be the right time to pay off debt, invest for the future or save for a rainy day.
Consider a diversified investment strategy that aligns with your financial goals and risk tolerance. A good strategy will consider your current financial needs, your long-term objectives, and the economic outlook. Remember, inherited wealth has the potential to secure your financial future if managed with care and prudence.
Inheriting assets creates a pivotal moment to reassess your financial landscape. It's an invitation to reinforce or redefine your investment philosophy. Rushing into high-risk investments or extravagant purchases can jeopardize the longevity of your wealth. Instead, consider whether liquidating high-risk assets you've inherited and reallocating them into a balanced, diversified portfolio aligns with your risk tolerance and investment horizon.
This is also an opportune time to establish an emergency fund, clear debts or enhance your retirement savings. An optimal goal is to chart a course that balances growth with preservation, ensuring that your inherited wealth works toward achieving your long-term objectives.
3. Plan for the long-term.
Inheriting wealth can impact your life goals and retirement plans. It’s an opportunity to reassess your financial roadmap and make adjustments. Do you want to retire early? Are there philanthropic endeavors you wish to pursue? Do you need to set up educational funds for your children?
You might also consider the benefits of estate planning, including setting up trusts, wills and health care directives to manage and protect your wealth. Estate planning is not just for the wealthy; it's a beneficial tool for anyone looking to manage their financial legacy responsibly.
Inheriting wealth should prompt a thoughtful review of your estate plan or be the catalyst to create one. Estate planning goes beyond drafting a will — it's about ensuring your assets are distributed according to your wishes with minimal legal hurdles. Trusts can be strategic tools for managing your wealth, offering control over how your assets are used by future generations and potentially providing tax benefits and protection from creditors.
Philanthropy can also play a role in your planning. Donating a portion of your inheritance can create a legacy that aligns with your values while providing tax benefits. Vehicles like donor-advised funds or private foundations can be advantageous for managing larger charitable efforts and can involve family members in philanthropy, instilling values of generosity and social responsibility.
Before you act, take a moment to breathe.
Inheriting wealth is more than just a monetary transaction; it's an event that can shape your financial trajectory for years to come. Handling it with informed care can ensure that it becomes a blessing and not a burden. Remember to navigate the tax landscape carefully, invest wisely and plan with the future in mind.
Inheriting wealth comes with the power to transform your life and the lives of others. It's essential to approach this windfall with a blend of gratitude and strategic thinking. Grasping the tax implications, investing with intention, and planning for the future can convert a temporary financial gain into a lasting legacy.
If you're navigating an inheritance, take the time to breathe and plan before you act. Wealth management is a marathon, not a sprint. Your objective might be to make informed decisions that will honor the legacy of your benefactors while securing your own financial future.
Take a moment to reflect on the potential of your inherited wealth. Consider how it can be leveraged not just for immediate gratification, but for long-term prosperity. Engage with your financial and legal advisers to chart a path that reflects your ambitions and responsibilities. With deliberate and informed actions, you can honor the legacy behind your inheritance while crafting your own.
- New Rules for Inherited IRAs Could Leave Heirs With a Hefty Tax Bill
- Six Steps to Take if You've Recently Inherited Money From a Loved One
- IRS Quietly Changed the Rules on Your Children’s Inheritance
- One Way to Secure Your Child’s Inheritance in an Uncertain Tax Future
- Your Home Would Be a Terrible Inheritance for Your Kids
Chris Giambrone is a co-founder of CG Capital™, a boutique wealth management firm based in New Hartford, N.Y. He is a CERTIFIED FINANCIAL PLANNER™ and Accredited Investment Fiduciary® (AIF®). Chris has also earned a Certificate in Retirement Planning from the Wharton School of Finance at the University of Pennsylvania.
Capital Gains Tax Exclusion for Homeowners: What to Know
Tax Breaks The IRS capital gains home sale exclusion can be a valuable tax-saving tool if you’re eligible.
By Kelley R. Taylor Last updated
Kiplinger's Mutual Fund Guide For 2024
Giant U.S. tech stocks dominate many of the top-performing names in Kiplinger's mutual fund guide, but small and foreign companies are well represented too.
By Nellie S. Huang Published
The Three Basic Components of a Good Estate Plan
Getting your estate in order so everyone knows what you want when the time comes can save your loved ones confusion and stress.
By Jason “JB” Beckett Published
Is Your Financial Adviser Listening to You?
Survey finds financial advisers and their clients might need to break out the talking stick. Repetition and summarizing are key to ensure your points are heard.
By Suzanne Norman, CIMA®, CPCC Published
Did You Get a Cash Windfall? The Case for Doing Nothing
An inheritance or lottery win can be a stroke of good fortune, but if you mismanage your funds, you could end up worse off than before your windfall.
By Samuel V. Gaeta, CFP® Published
How to Use Your Estate Plan to Save Tax Now: A Timely Update
Consider an upstream basis trust and a general power of appointment for an older family member to reduce capital gains taxes on highly appreciated assets.
By John M. Goralka Published
Three Common Mutual Fund Misconceptions Debunked
Mutual funds let investors access a basket of securities rather than buying individual ones on their own, but there are some misconceptions about them.
By Brian Spinelli, CFP®, AIF® Published
529s: No Longer the Ho-Hum Investing Device for College
Changes to the plans allow for the savings to be rolled into a Roth IRA, as long as certain rules are met, if a child decides not to pursue their education.
By Neale Godfrey, Financial Literacy Expert Published
To Make the Case for Equities in the Long Term, Look to the Past
While cash yields are attractive now, if we look at the performance of equities in the past, we can expect that, going forward, they could be a better bet.
By David Blanchett, PhD, CFA, CFP® Published
Workplace Financial Coaching Has Become Ever More Important
Employees face growing challenges to their financial wellness today, so it’s more critical than ever that employers provide the help they need to navigate them.
By Greg Ward, CFP® Published