No inheritance is ever cut and dried. Here are at least 6 tips to consider. Make sure to consult with a professional in tax and estate planning.
A sizeable inheritance can represent a life-changing opportunity. Here are six tips to help you prudently manage your windfall.
Tip 1: Consult With a Financial Professional and Tax Professional
Depending on the type of inheritance (e.g., investments, life insurance, retirement account), you could be dealing with substantial federal and/or state inheritance taxes. Working with a financial advisor and/or a tax professional could help you plan the sale of any assets and deal with the tax implications. For example:
• If your inheritance was from your spouse, there may be no taxes due.
• Life insurance proceeds are usually tax free.
• Non-retirement assets are taxed when sold, and those assets typically receive a “step up” in cost basis. That means that any capital gains tax you owe will be based on the asset’s fair market value at the date of death of the benefactor.
If you inherit an annuity or traditional workplace retirement account or IRA, you will have to pay taxes on the distributions. Be very careful when taking your distributions. For example, if you cash out your uncle’s IRA and roll the money over into your own IRA, the entire amount of the rollover will be subject to ordinary income taxes.
Note too that there are considerations for spouses rolling over their deceased spouse’s retirement account.
Tip 2: Park the Cash
Before you make any plans or major purchases, stop. Deposit the inheritance or investments in a bank or brokerage account. If you are married, you need to determine whether to put the account solely in your name or jointly with your spouse. Note that inheritances are considered separate property, in case of divorce. However, once they are commingled in a joint account, those assets lose that protection.
Tip 3: Cut Down/Eliminate Your Debt
Your inheritance may allow you the ability to pay off your debt, including your mortgage. But first consider paying off those loans with higher interest rates, such as credit cards, personal loans, and car loans. Then consider paying off your mortgage. Also fund an emergency account with at least six months’ worth of living expenses.
Tip 4: Think About Your Other Goals
Identifying your financial goals can help you determine what types of investments to make or other types of accounts to open. These goals could include:
• Contributing to charity
• Setting up a trust or foundation
• Paying for a family member’s education
• Helping out loved ones
• Adding to your retirement savings
Tip 5: Review Your Insurance and Estate Planning Needs
If you’ve inherited a significant sum, it may be wise to increase the liability limits on your homeowners and automotive policies. If you inherited jewelry, artwork, or real estate, you may need to increase your property and casualty coverage. Consider an umbrella policy. Does the inheritance inflate the size of your estate so that it will be subject to estate taxes? Are you thinking about setting up a trust to provide for family or charity?
Tip 6: Do Something Nice for Yourself
Set aside a small percentage — no more than 5% to 10% — of your inheritance for “splurges.” Take a trip. Buy a new car. Just be sure to keep it small. After all, inheritances don’t grow on trees.
This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your tax professional to discuss your personal situation.