What Should You Do With an Inheritance From Your Parents?
Posted on June 4, 2024 by Katherine Fox.
What Should You Do With an Inheritance From Your Parents?
First, I’m sorry for your loss.
Understanding how to make the most of your inheritance might be low on your list of priorities, and that’s OK.
If you’re Googling because you’re stressed and worried you’re going to do something wrong, take this as permission to bookmark this page and come back to it when you have more time and mental space.
If you’re past the worst of grief and estate settlement logistics, keep reading for the information you need to learn how to make the most of an inheritance from your parents:
What is the first step I should take after getting an inheritance from my parents?
What are the tax consequences of an inheritance from my parents?
What should I do with cash I inherited from my parents?
What should I do with stock I inherited from my parents?
What should I do with real estate I inherited from my parents?
How should I invest an inheritance from my parents?
I’m Katherine and I’m a CFP® and investment advisor for inheritors.
I’m here to help you through this journey, whatever your needs are.
If you’re trying to get up to speed, check out the 20 Terms Inheritors Need to Know.
And if you’re deep in the weeds and don’t know what to do next, schedule a FREE consultation to see how I can help you navigate receiving an inheritance from your parents.
What is the first step I should take after getting an inheritance from my parents?
The first step you need to take after getting an inheritance from your parents is to sit back and take a breath.
You’ve been through a lot. You don’t want to make decisions when your mind is grieving, whirling, and distracted.
Your inheritance will still be there in months, or even years.
During this “cooling down” period, your only goal is to make sure that the inheritance from your parents is held safely:
Cash inherited from your parents should be held in a checking or savings account, ideally a high-yield savings account.
Stocks, mutual funds, or ETFs inherited from your parents should be put into a brokerage or inherited IRA account in your name.
Real estate inherited from your parents should be secured, with the locks changed and access limited to you and trusted friends/family or a property manager.
Take as long as you need to work through your grief.
Don’t pressure yourself into making decisions quickly. This is the #1 way that I see inheritors waste money from their parents - they start spending money before they have had a chance to reflect and put a plan that aligns with their long-term goals in place.
What Should You Do With an Inheritance From Your Parents?
After getting an inheritance from your parents, you need to understand what you are inheriting, what taxes you may have to pay, and how an inheritance can help you build toward your vision for the future.
What are the tax consequences of inheriting from my parents?
There are three areas you need to understand about taxes after receiving an inheritance from your parents:
1.lEstate and Inheritance tax
There is a Federal estate tax for large estates (above $13.6 million for an individual) and several states impose estate taxes. Estate taxes are paid by the estate itself and are not the responsibility of individual heirs.
If your parents lived or owned property in a state with an inheritance tax (NE, IA, MD, KY, PA, NJ), you may be responsible for paying an inheritance tax.
2. The Step-Up In Basis
Most inheritors will receive a step-up in basis on assets they inherit from their parents. The step-up in basis is preferential treatment in the tax code for the assets of deceased persons.
Let me explain:
The “cost basis” of stock/real estate/property is the value for which the property was purchased.
When you sell an appreciated assets you pay capital gains taxes on the difference between the cost basis of the item and the value for which you sell it.
Example:
If you buy an investment property for $500,000 and sell it five years later for $1,000,000, you will owe tax on $500,000 in realized capital gains.
When someone dies, generally the cost basis of their assets is “stepped up” as to that assets value on their date of death.
Example:
You die holding the same investment property, which is worth $1,000,000 on the day you die. The property gets a step-up in cost basis, which is now $1,000,000.
Your heir inherits the property and sells it 3 months later for $1,000,000. Your heir owes no capital gains tax because they are selling the property for its cost basis.
If you received assets that got a step-up in basis from your parents, you generally will not have to worry about the tax implications of those assets.
There are two major exceptions for assets that don’t receive a step-up in basis:
Assets held within an irrevocable trust at the time of your parents death
Assets for which you were named on the deed and inherited via deed transfer
3. Taxation on inherited IRAs and 401(k)s
If you inherit a traditional IRA or 401(k) from your parents, you will be dealing with taxes for awhile.
That’s because every dollar you pull out of a traditional retirement account is treated as taxable income.
And for most people who inherit a retirement account from their parents, they will have to FULLY empty that account within 10-years after their parent’s date of death.
To avoid a major tax hit (i.e., inheriting a $1 million IRA and taking it all out in year 10 and realizing $1,000,000 of taxable income and at least 37% taxes) it is advisable to take distributions from an inherited IRA over a 10 year period.
Some account holders may have to take distributions annually, if the parent they inherited their IRA from was already taking their Required Minimum Distributions.
What should I do with cash I inherited from my parents?
If you inherit cash from your parents, your first step is to get it earning interest for you.
Open a high-yield savings account where you cash will be FDIC insured and can earn ~5% interest.*
*For inheritors who received more than $250,000 ($500,000 in a joint account) Sunnybranch partners with Stonecastle Cash Management to offer FDIC insurance for cash up to $25 million - reach out to me to learn more. ‘
Once your inherited cash is safely earning interest, your next step is to figure out if you want to keep your inheritance cash for short term needs or invest it to help you reach your future financial goals.
Skip ahead to “how should I invest an inheritance from my parents” to get the full scoop.
What should I do with stock, mutual funds, or ETFs I inherited from my parents?
If you inherit stock from your parents, your first step is to open a taxable brokerage account to hold your inherited positions.
Your next step is to understand the positions you inherited:
What stocks and/or funds did you inherit?
If you inherited mutual funds or ETFs, what are the expenses of those funds?
Are the stocks/funds you inherited aligned with your risk tolerance?
What would the tax implications (see above) be of selling your inherited stocks/funds?
If you need help understanding inherited stocks, mutual funds, or ETFs, reach out to me to see how I can help.
Often, our parent’s portfolios are more complex than our own needs. If you received a step up in basis on inherited assets, you may choose to fully liquidate your inherited portfolio of stocks. From there, you can build a portfolio in line with your risk profile, which invests in companies aligned with your values.
What should I do with real estate I inherited from my parents?
If you inherit real estate from your parents, your first step is to secure the property, ideally changing the locks and installing an alarm system.
Your next step is to understand what you want to do with the real estate:
Is this a property you would want to live in permanently?
Do you want to keep it as a vacation home or investment property?
What is the income potential of the property?
Is there a mortgage on the property?
What are the annual maintenance, property tax, and insurance costs of the property?
Does the property need significant updates or have large deferred maintenance costs?
What would the tax implications (see above) be of selling this real estate?
Whether to keep or sell inherited real estate is an intensely personal decision. Although real estate can be a fantastic way to build generational wealth, it is often a significant drain on money, time, and energy.
Many inheritors choose to liquidate inherited real estate and invest proceeds in the market to reduce complexity and increase the liquidity of their inheritance. This is a perfectly valid choice if it aligns with your needs and long-term goals.
How should I invest an inheritance from my parents?
How you invest an inheritance from your parents will depend on your personal goals and timeframe.
Your first step is to write down your short, medium, and long-term goals. These may or may not be related to your finances.
For example:
Short-term goal (1-2 years):
I want to buy a $700,000 home in the next 2 years.
Medium-term goal (3-5 years):
I want to take a six-month sabbatical from work to travel in 5 years.
Long-term goal (5+ years):
I want to retire and never work again at age 55
Your next step is to assign dollar values to each of these goals. This is where working with a fee-only financial advisor can be helpful - reach out to me if you have questions!
Money needs for short-term goal:
I can afford a $400,000 mortgage so I need a $300,000 down payment
Money needs for medium-term goal:
I need $150,000 to replace 9 months of my income - six months to travel and 2 months to find a new job.
Money needs for long-term goal:
This depends on how much you plan to spend per year in retirement and what other income sources you have available. A “safe” number may be anywhere from $3 million to $8 million saved.
Once you have your goals written down and have assigned a rough dollar value to each goal, the next step is to invest your inheritance in line with these goals.
Money needed for the short-term
Should be held in an FDIC insured high-yield savings account
Money needed for the medium-term
Can be held in a FDIC insured high-yield savings account. Depending on your risk tolerance and the flexibility of your goals, you may also choose to hold that money in a money market or bond fund.
Money needed for the long-term
Should be invested in the stock market in a globally diversified portfolio that matches your risk tolerances and aligns with your values.
If you need help building a portfolio for the long term, reach out to me to learn how Sunnybranch can help support your goals by aligning your money with your goals and your values.
Let’s take the next step together
Understanding what to do with a sudden windfall is not easy. The newly wealthy can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms You Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a fiduciary, fee-only financial planner to learn how Sunnybranch can help you build a plan to manage, grow, and give your sudden wealth.