Inheriting money is a bittersweet event. While we may suddenly find ourselves in a financially advantageous position, we have also suffered the loss of a relative or friend. There are usually a number of questions: How much tax do I owe? Should I sell the character or keep it? What do I do with the funds…pay off debt, gift to my children, invest for the future?
Tips Regarding Your Inheritance
• Taxes. In general, inherited assets are not taxable income, but the income earned by the assets are. For example, you don’t report the inherited CD as income, but the interest paid by the CD is taxable income. There are also certain assets that generate more taxable income than others. For example, if you are the beneficiary of an IRA, you can close the IRA and receive the cash. But, by doing that you will pay tax on every dollar cashed out. In general, IRAs should be converted to inherited IRA accounts, so that you only pay tax on the minimum distributions each year. Annuities are also tricky. When you take a dispensing from an annuity, the profit is paid out, and taxed, first. So if you inherit an annuity, make sure you find out how much is taxable before you complete the claim form. Most annuities will allow a beneficiary to take distributions over five years to better manage the tax liability. If you will be receiving more income due to the inherited assets, be sure to contact your tax advisor to ask about increasing your estimated tax payments.
• Spending. It is human character to use our inheritance on something we’ve always wanted. This can be good up to a point, but when used unwisely, the consequences are long-term. Consider paying existing debts first, particularly those with higher interest rates. Or consider using some of the funds for an asset-based Long Term Care policy.
• character. If we’ve inherited real estate, confirm that character taxes and insurance are up-to-date, and the locks are changed. Consider whether to keep up or sell the character. If the rent you can receive is only 1% of the market value of the character, it may be less stressful to sell and buy a CD!
• Investing. Make the money work for you and invest wisely. If you were not already working with a financial and tax advisor, consult these professionals and seek their advice. Be sure you understand the risks involved. Beware the get-high-quick schemes.
• Estate Planning. Receiving an inheritance is a good opportunity to review your own estate plan. If the inheritance is going to make your estate unprotected to estate taxes, consider a timely disclaimer, before you accept the inheritance. If married, decide whether you will keep it as your separate character or transform to community character. Consult your attorney to ensure your own plan is up-to-date.
Although these initial decisions seem complicated, they can have a profound impact on how long your newfound wealth will last. The effects of good planning will last for years and can already be passed on to your own beneficiaries.