Receive an inheritance recently? Here is expert financial advice

Receive an inheritance recently? Here is expert financial advice

In a nutshell, an inheritance is just like a gift but with the added benefit of a full step up in basis. It is not earned income. An inheritance may provide substantial security in your life. The following list provides some basic income tax consequences for assets received through inheritance along with some advice once an inheritance is received. Be aware that if assets are received from a trust upon a death the tax basis of the assets may be different and therefore the rules below may not apply.


Do

Do know what is taxable and non-taxable

Taxable:

  • Annuities (amount over the initial investment)
  • Investment income paid after death
  • Payments from employer - wages, salaries, bonuses, commissions, vacation pay, sick pay
  • Traditional IRAs (except nondeductible contributions), deferred compensation, qualified pension plans, profit-sharing plans, 401-Ks

Non-Taxable:

  • Life insurance proceeds
  • Cash, bank accounts, CDs
  • Stocks, bonds, mutual funds (value on date of death is not taxable because basis steps up or down to Fair market value, or FMV, as of that date)
  • Residence, personal or rental, other real estate (value on date of death is not taxable because basis steps up or down to FMV as of that date)
  • Cars, vehicles, household goods, jewelry, other personal property (fair market value on date of death is not taxable because basis steps up or down to FMV as of that date)
  • Roth IRA held more than 5 years
  • Non-deductible portion of non-deductible IRAs

Do invest and save

Consider funding your retirement and/or 529 college savings plan for your children. Consider diversification given the volatility of the stock market and look into in relatively safer investments since inheritances are typically a once-in-a-lifetime event. The important thing is to invest and save your inheritance for your future needs rather than blowing it all on a car, for example.

Do pay off high-interest debt

It may make more sense to pay off credit cards and auto loans before using the money to pay off some of or even your entire mortgage, but depending on your investment strategies with the inheritance, the best investment may be paying off your mortgage as well. High-interest debt will only continue to build up if you don’t pay it off sooner than later.

Do manage income taxes

Depending on the assets you inherit, consider the tax implications such as distributions on an annuity or selling a particular asset. You will have to pay income taxes on the types of things listed above, so be sure to include this expense in your budget as well.

Do consult with a financial advisor

Financial planners will allow you to align both short-and long-term financial goals for you, your spouse and your children/grandchildren. Consult with a financial advisor to help you decide what it is your are going to do with your inheritance. And be sure that you cover all your basis and ask all the questions you can in order to ensure you create the proper financial plan for you and your family.


Don't

Do not spend it all

People tend to change their lifestyle upon a windfall and end up quitting their job or retiring early. Don’t spend all of the money without planning for the future. You will most certainly regret it if you do.

Do not place the inheritance in joint accounts or in a living trust with a spouse

Inheritances are separate property. If you live in a community property state like California, you will be able to keep it in the event of a divorce unless it is commingled with joint accounts. Whether or not you believe that you will be with your spouse for a lifetime, protect yourself by putting the inheritance in your name only.

Do not lend money

Don’t lend money to friends and relatives. It’s a right-hearted gesture, but it can backfire and ruin relationships.

Do not take risks

Don’t get involved with financial schemes or risky ventures. Don’t let others exploit you because of your new money.

Do not make big financial decisions

Don’t make any big financial decisions for at least six months, to maybe even a year. If someone just died, you’re not in an emotional state to make decisions like that.


Summary
Jumping cartoon

Receiving an inheritance leaves most people feeling overwhelmed and confused. Figuring out how to manage it can be financially and emotionally draining on something that should be a real blessing. Plan for your future and consult a financial advisor that you trust will help you make the right decisions.


More expert advice about Estate Planning

Photo Credits: © pogonici - Fotolia.com; Check Man, Cross Man and Jump Man © ioannis kounadeas - Fotolia.com

Bradford L. Hall, CPAManaging Director

As the Managing Director of the Hall & Company, Brad is actively involved in all aspects of taxation, auditing and business planning. He has over thirty years of experience in public accounting. Brad's core strengths as an Irvine CPA are in the ...

View Full Profile