Receiving an inheritance is often complicated. While an influx of cash or other assets might be welcome, it may come at a time when you are grieving the loss of a loved one. Also, depending on the types of assets and other factors, you may feel confusion or uncertainty about the consequences or best course of action.
"People should understand how life-changing an inheritance can be, and make sure they understand what they are giving up if they spend it too quickly," says certified financial planner Liz Windisch, founder of Aspen Financial Management in Centennial, Colo. "People very often blow through inheritances immediately, so people should think about their long-term goals for their life or retirement." She says it's important to explore how this money can fit into the larger picture of your life goals.
Here are six things to think about to manage an inheritance successfully.
What to know when you inherit assets
The first thing to consider is the type of asset you're inheriting, as you may need to plan for or manage them differently. According to Windisch, some common types of inherited assets and some considerations include:
- Cash. Inherited cash is not taxed as income, but you may owe federal or state inheritance or estate taxes if it exceeds certain thresholds.
- Retirement accounts. This can be the most complicated type of inheritance. Traditional retirement accounts such as individual retirement accounts (IRAs) and 401(k)s are taxed as income, while Roth accounts are not. You must take the money out of the account within a specific time frame, depending on your relationship with the deceased. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which went into effect on January 1, 2020, changed the threshold for many people to 10 years and made other changes to retirement accounts.
- Securities or real estate. Securities and real estate are subject to a "step-up in basis" adjustment in value upon the death of the owner. This adjustment in value becomes the new baseline, and the person inheriting these assets only owes taxes on growth from that point on.
- Life insurance. The proceeds that a beneficiary receives from a life insurance policy are typically tax-free.
Planning for an asset transfer
Once you understand the type of asset you're inheriting and the potential tax consequences, you will have an idea of the time frame within which you're working. While you may receive a transfer of the assets in the short term, you should avoid rushing into any decisions about the next steps, says certified financial planner Patti Black, a partner at Bridgeworth, LLC, a financial planning firm in Birmingham, Ala.
You may still be grieving and not in the best frame of mind to make decisions, she says. And, if the inheritance is large, it's a good idea to get some help from a financial planner, tax attorney, insurance agent, or a combination.
"[Find] somebody who can sit down with you and look at the overall picture, and help with making decisions," she says. For example, how will you decide whether to use the inheritance to pay down debt, save for education or retirement, or invest it? If you don't need the money, you may wish to donate it to charity or split it among family members. These are decisions that require planning and clear thinking.
Looking to the future
Your inheritance may also put you in a position to make long-term planning decisions. For example, if you receive a large asset transfer, you may want to look at a form of trust, typically established by an estate planning attorney, which could shield your assets and provide for beneficiaries that may include family members or charitable organizations. You may also want to make other types of investments to honor the legacy of the person who left the gift to you. Or you may decide to liquidate the assets and use the proceeds to start a business.
"Tying the money to specific goals you have for your life can go a long way toward successfully managing an inheritance," Windisch says. The key is to take your time and get the help you need to make the right decision for you.