What Should You Do After Inheriting Money From Your Parents?
What Should You Do After Inheriting Money From Your Parents?
After learning you will receive an inheritance from your parents, your first step is to get answers to common questions for inheritors.
When you’ve received inheritance money from your parents, you can start building a plan to manage your inheritance. This plan should include:
Reflecting before making financial decisions
Learning what assets and accounts you inherited
Understanding the tax consequences of your inheritance
Finalizing a plan to spend, invest, and give your inheritance in line with your long-term goals
Posted on February 29, 2024 by Katherine Fox.
What Should You Do After Inheriting Money From Your Parents?
After you inherit money from your parents, think and reflect before making financial decisions.
The death of a parent can be a traumatic event. No rule says you need to understand your inheritance or make a plan to manage your inheritance in the weeks or even months after a loved one dies.
Instead of stressing about the ins and outs of inherited wealth, focus on your mental health and relationships with loved ones. Too many inheritors make rash decisions with new wealth while in the fog of grief and regret their decisions in the months and years that come.
After you have moved through the worst stages of grief, start building a plan to manage your inheritance by thinking about how the money can support your goals and vision for the future.
Ask yourself these questions:
What do I value most about how I spend my time currently?
How can my inheritance allow me to do more of those activities?
What are my most important relationships?
How can my inheritance support these relationships?
What life/financial goals have I not met yet?
How can my inheritance help me meet these goals?
Write answers to these questions and keep them in a place you can use for reference. Your answers should help guide discussions of how you will use your inheritance to support the most important parts of your life and bring your future goals into closer reach.
There is no “right” amount of time to spend before you are ready to deal with an inheritance. Some people take comfort in logistics and may be able to make decisions weeks or months after a loved one days. Some people may not be able to make decisions for years.
Give yourself grace to move forward on your timeline and avoid listening to anyone who tells you what you “should” be doing.
After inheriting money from your parents, learn what assets and accounts you inherited.
Depending on the size and complexity of your parent’s estate, you may have inherited different investment assets. Inheritors can receive assets through different account types, including:
Checking/savings accounts
Taxable brokerage accounts
Pre-tax retirement accounts
Roth retirement accounts
Health savings accounts
Inheritors can also inherit assets outright, or held in trust for their benefit.
What Should You Do After Inheriting Money From Your Parents?
Regardless of how you inherit, several common types of assets may be part of new wealth inherited from your parents:
Cash and Cash Equivalents: These are highly liquid assets like money market funds, certificates of deposit (CDs), and Treasury bills.
Equities (Stocks): A share of stock represents ownership in a company. When an individual holds stocks, they become a shareholder and have a proportional claim on the company's assets and earnings.
Bonds (Fixed Income): In buying bonds, investors lend money to a government or corporation in exchange for periodic interest payments and the return of the purchase/principal amount at maturity.
Mutual Funds and Exchange-Traded Funds (ETFs): These are investment vehicles that pool funds from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities.
Real Estate: Real estate investments could include physical properties, alternative investments holding residential or commercial real estate, or real estate investment trusts (REITs)
Precious Metals: Assets like gold and silver.
Alternative Investments: A range of non-traditional assets including hedge funds, private equity, venture capital, and cryptocurrencies. These assets are generally illiquid and may be difficult to sell.
Collectibles: This includes tangible assets such as art, antiques, cars, or coins. These items should be valued by a qualified appraiser and may require a specialized team to sell.
“The most important step after inheriting money from your parents is to embark on the life-long process of deciding how to spend, save, invest, and give your inheritance in line with your financial and life goals. ”
After inheriting money from your parents, understand the tax consequences of your inheritance.
A key step to managing an inheritance from your parents is understanding what, if any, of your inheritance will count as taxable income. Most inheritors won’t pay taxes on their inheritance. But not all. You could pay taxes on your inheritance depending on the type of assets you inherit.
There are four primary reasons a beneficiary would have to pay taxes on an inheritance:
1.iThe deceased person lived in a state with an inheritance tax.
Inheritance tax is a tax imposed on the beneficiaries who inherit assets from a deceased person. Unlike estate tax, inheritance tax is not levied on the total value of the estate but on the specific amounts received by individual heirs.
Inheritance tax is assessed based on the value of the inherited assets received by each beneficiary. The tax rate and exemptions vary between states that impose inheritance taxes.
Many states exempt the children of a deceased person from inheritance taxes.
2. You inherited income-producing assets.
If you inherit assets that generate income, you will pay taxes on the income generated as long as you hold the assets.
This income could be from dividend stocks, rental property, bonds, or other sources. If you are not used to planning around investment income it can be a shock in the first tax year when your tax bill is much higher than expected.
You can reduce your tax liability by diversifying out of inherited positions that generate income and toward assets focused on long-term growth and appreciation.
3. You inherit a pre-tax (traditional) IRA, 401k, or other retirement account.
You may not pay taxes upon receipt of a pre-tax IRA, 401k, or other retirement account, but they can cause tax issues for you down the road.
All distributions from pre-tax retirement accounts are taxed as ordinary income. Most beneficiaries who inherit one of these accounts are required to fully empty the account within 10 years of the deceased person’s date of death.
If you inherit a large retirement account, you could have a 10-year tax headache. Inheritors who live in states with income tax should pay special attention to tax planning, as income tax on IRA distributions could reduce the size of their inheritance by almost 50%.
4. You inherit assets that didn’t get a step-up in basis.
Inheritors who inherited property by deed or through an irrevocable trust may not get a step-up in basis on inherited assets. If this describes your situation, you should ask your financial advisor or CPA to advise on the tax consequences of your inheritance.
Under current tax laws, the cost basis of inherited assets is adjusted to their fair market value at the time of the decedent's death. This step-up in basis can result in substantial tax savings when the heir eventually sells the inherited assets.
If an individual inherits assets that have appreciated since the deceased acquired them, the heir's capital gains tax liability is calculated based on the value of the stocks at the time of inheritance, not the original purchase price. This can lead to tax savings, especially for highly appreciated assets.
LEARN MORE ABOUT MANAGING AN INHERITANCE
The last step after inheriting money from your parents is building a plan to spend and invest your inheritance in line with your long-term financial and life goals.
The most important step after inheriting money from your parents is to embark on the life-long process of deciding how to spend, save, invest, and give your inheritance in line with your financial and life goals.
This process may be best undertaken with a financial advisor who specializes in helping inheritors manage inherited wealth. It involves building a clear picture of how inherited assets can support your vision for the future and grow in line with your values and priorities.
Building a plan to spend and invest your inheritance in line with your long-term financial and life goals involves three main steps:
1.lOutline your most important life and financial priorities.
You already took the first step in this process by answering the questions at the beginning of the post:
What do I value most about how I spend my time currently?
How can my inheritance allow me to do more of those activities?
What are my most important relationships?
How can my inheritance support these relationships?
What life/financial goals have I not met yet?
How can my inheritance help me meet these goals?
Use these answers to define your most important short, medium, and long-term goals.
2. Once your goals are defined, have a financial advisor who works with inheritors help you decide how much of your inheritance should be used for short-term, medium-term, and long-term goals.
Short-term goals are immediate needs. Maybe you want to use part of your inheritance to take your family on a trip, pay down debt, or finally get that new kitchen. Money needed for short-term needs should be kept in an FDIC-insured account to ensure it is fully liquid.
Medium-term goals are in a 1-5 year timeframe. This could include a down payment on a future home, a child’s school or college expenses, or other goals that require a significant cash outlay. Money needed for medium-term needs may be kept in an FDIC-insured account. Bond funds or other cash-like investments may be appropriate depending on your risk tolerance and the time-sensitivity of your needs.
Long-term goals will happen in 5 years or more. They could include retirement or could be unspecified.
3. Explore how you can use your inheritance to support your values and create positive impact in the world around you.
Receiving a large inheritance is an incredible privilege. Being wealthy confers a new obligation to investigate how your wealth and privilege can create positive change in your local, national, or global community.
This impact looks different for everyone. As you are considering how you will use your wealth to support your values, think about which of the following options resonate most strongly:
Using your wealth to stop working and focus on volunteer commitments or political organizing. This may include taking a part-time or lower-paying job at a non-profit or political organization.
Invest your wealth in investments that generate returns while creating a positive impact and supporting the causes that are most important to you.
Set aside a portion of your investments that will be used to support catalytic impact in companies or ideas that may have below-market-rate returns.
Put a portion of your wealth into a charitable account for donations and below-market investments into non-profits or impact-focused companies.
Increase your annual philanthropic, personal, and/or political giving.
Involve family or close friends in your annual donations and build a core impact statement and theory of change together.
Let’s take the next step together
Understanding what to do after you inherit money from your parents is not easy. Heirs 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 financial planner for inheritors to learn how Sunnybranch can help you build a plan to manage an inheritance from your parents.
