The Challenges of Inheriting Wealth
Over the years that I’ve been helping people figure out their money (my whole career), one thing I’ve seen consistently is that most people seem to need a reason to hire an investment advisor. I always counsel people that good financial planning happens at every stage of life, and I try to help out in my practice the same way I try to help out with these blog posts – by touching all the aspects of your life where it intersects your money, so you can create a plan that helps you achieve your goals. But nobody really thinks about working with me until, usually, one of two things happens: They retire or they get an inheritance. Something about a big chunk of money seems to break through the everyday inertia of avoiding financial planning.
I talk about retirement a lot, so today let’s talk about inheriting wealth.
What is a “Life-Changing Amount of Money”
The Federal Reserve tracks a ton of data about the economy, and regularly produces a report called the Survey of Consumer Finances. The most recent survey (2017) found that the average inheritance was $707,000, and when a trust fund was used to transfer wealth, the average was $4.1 million. While those numbers may provide context, in reality what your current financial position is and at what age you inherit money are what really define whether it changes your life.
Unfortunately, according to the National Endowment for Financial Education, an estimated 70% of people who suddenly receive a large amount of money go through it all in just a few years. But with some thoughtful planning, whatever the size of the inheritance is it can make a real difference.
Where the assets are matters
Because of the favorable tax treatment, assets in taxable accounts are usually your best bet if you want to use the inheritance for a short-term goal, like paying down debt or down payment on a home.
If you inherit a tBesides personal possessions or collections, the most common bequests are investment accounts – but these come in a lot of different forms. For instance, if you inherit a 401(k) or a regular taxable brokerage account, there are different rules on both taxes and how you can access the funds. And because your financial picture right now and your plan for the future probably look a lot different than your benefactor’s you’ll probably want to move those investments around, and maybe sell out of them completely.
If you inherited stocks, mutual funds or other investments in a taxable account, there’s something called the “step up in basis” that can benefit you. Essentially, the cost basis of each asset (which might have been held for decades and could have appreciated a great deal) is increased from the original price to whatever the value is on the day of the original owner’s death. That becomes the new cost basis for tax purposes when the asset is sold. For example, if your favorite great uncle loved to play Monopoly and bought Hasbro in 1980 and left it to you in 2018, the price of the stock would have increased by 104,000% over those 38 years. But you won’t have a giant capital gains tax bill. If you sold it in 2019 you’d only pay the difference between the 2018 price and the price you sold it at.
Tax-deferred accounts like an IRA, things get a little more complicated. Because of the rules around tax-deferred accounts, you have to roll them over into a new “Inherited IRA” account, and you’ll need to take required minimum distributions (RMDs). (Those were waived this year by the CARES Act). But starting in 2021 you’ll need to take an RMD every year – the amount is based on your age and life expectancy – and pay taxes on the amount. You can take more than the RMD, but if you’re still working you may want to wait to begin accessing the account until you retire and you’re presumably in a lower tax bracket.
Sound complicated? It is a little bit – and we haven’t even talked about spending the money yet.
I usually recommend that people have a sort of holding period of about six months, in which they don’t make any changes but instead give some thought to what they want to do. Sometimes that’s about thinking through what would work best in your life, and it can also be about honoring the memory of your benefactor.
If you would like to talk about this, feel free to reach out to me. As always, thanks for reading. KB