Are You Inheriting Money? Don’t Miss These 5 Steps

Inherit

Are You Inheriting Money? Don’t Miss These 5 Steps

* This article was originally published on Oct. 3, 2018. It has been updated for 2021.

When loved ones pass, they often pass on their belongings to beneficiaries they know will care for the items they cherished during their lifetimes. Many also leave financial assets to those they’ve left behind in the form of cash, trusts, real estate, and/or IRAs and qualified retirement plan accounts.

While many recipients have plans for physical belongings, it’s often more difficult for beneficiaries to decide what to do when they receive monetary inheritances. Whether those receiving money know what their loved ones intended for them to do with the inherited funds or not, it’s important to take time and make educated, informed decisions about what to do with the money. That’s where financial planning comes in.

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Some beneficiaries receive inheritances as unexpected gifts while others know the details while their loved ones are still with them and can prepare in advance. But losing a friend, family member, or former acquaintance is never easy, and those receiving inheritances must often make tough financial decisions at difficult times in their lives. Unfortunately, this can lead them to make poor choices. From not properly managing their funds and increasing unnecessary spending to simply not knowing what to do or not doing anything with their financial gifts, receiving an inheritance can turn from a windfall to a woe quickly.

That’s why we’ve created this list of steps to help you make the right decisions for yourself and your inheritance.

5 steps beneficiaries can’t miss when inheriting money

1. Understand the tax implications.
First of all, it’s important that you know how much of your monetary gift will be left for you to use after taxes. An inheritance can be subject to federal estate or state estate tax — aka death tax or inheritance tax — and the earnings of the estate may be subject to income tax. State-level tax aside, this all depends on how much in lifetime gifts your loved one made and how large their estate was at death.

Lifetime gift and estate tax exemption — As of 2021 through 2025, a person can give up to $11,700,000 during their life or at death — married couples can double that amount, in total — without paying any gift or estate taxes. If combined lifetime gifts and the deceased’s estate was under this amount, no federal estate taxes apply. If the total is over that amount, federal estate taxes may apply.

After 2025, the lifetime exemption amount reverts back to $5.49 million (adjusted for inflation) unless Congress makes these changes permanent.

Income tax — Inheritance is generally not subject to income tax.  However, while an estate is being probated or a trust administered, the assets within the estate or trust may be earning income. This income is often passed-through, tax-wise, to the beneficiaries of the estate or trust. This means that they pay taxes on the income — even if the estate or trust earns that income.

State inheritance or death tax — Nineteen states impose some form of tax tied to the death of an individual. In some states, this tax applies to the estate itself. In others, the tax applies to the inheritance recipient. Colorado does not have an inheritance or death tax. 

2. Follow through on your loved one’s wishes.
For those who had the opportunity to discuss wishes with a loved one, this step may be a bit easier. Others may receive direction or suggestions on what to do with the money from an executor in charge of the deceased’s last will and testament or from the predecessor’s friends or family. Still others may receive an inheritance sans direction or to use as they choose. 

No matter the situation, however, it’s important for you as a beneficiary to consider how the deceased would have wanted you to use the money. Was it to make your life, the world, or your community a better place? You may choose to honor the life of the loved one you received your inheritance from by following through on his or her wishes. 

It’s also noteworthy to know, however, that this isn’t a requirement — even for those who receive directions or suggestions. In the end, it’s up to the beneficiary to choose whether to make such a gesture. And there’s no shame in deciding to use the money for your own purposes or otherwise make the best decision for yourself and your circumstances.

3. Consider your own financial goals.
It’s important you revisit your investments and goals once you know how much you have to work with and an idea of how the deceased may have wanted you to use it. Often, the best place to begin is to make sure you have your financial basics covered. In general, you’ll want to:

Start by building a strong financial foundation: Ensure you have enough in an emergency account to cover three to six months of living expenses.

Consider paying off debt like student loans or your mortgage.

Focus on saving for your child or children’s higher education funds and your own retirement. 

Pro Tip: As you deploy your inheritance proceeds, it’s important to consider the tax implications of selling inherited assets. Currently you’re allowed to recognize a step-up in cost basis for inherited assets. For example, you inherit a stock that your recently deceased mother bought for $10 a share. On the date of her death the stock was trading at $30 a share and you wish to sell it now when it’s trading at $33 a share. Because of this step-up in cost basis you only recognize the $3 capital gain instead of $23.

Reaching your goals more quickly may require investing in more than one of these areas at the same time. In this case, a holistic understanding of your financial position is especially important.

4. Come up with a cash-flow plan.
Once you have considered your goals, it’s time to establish a plan for how you’ll use your inheritance and how much you can allocate toward achieving each goal. How could the gift could impact your spending, retirement contributions, and savings for other long-term goals? 

It’s generally a good idea to avoid spending your inheritance away on items that aren’t included in your financial plan. Instead, see how much more you can now contribute to reaching the goals you established before you received the gift — and whether you can achieve them more quickly — by adjusting your cash flow plan accordingly.

5. Do your own due diligence: Plan your estate.
Inheritance planning doesn’t end once you decide how to use a loved one’s gift. As a beneficiary, you should also prepare to leave your own legacy by planning your estate. Do you want to leave a monetary gift to a loved one when you pass? When you plan your own estate early on in life — and you should —  you can adjust it as necessary and as you see fit as time passes. This allows you the time you need to plan along with the peace of mind and comfort of knowing your assets will be distributed according to your wishes.

Whether you’re inheriting a financial gift or planning your own estate, making these decisions can be tough, and making them on your own can amplify the difficulty. That’s why many beneficiaries choose to work with their financial planners. 

We’re here to support you in making the right financial choices at a difficult time. We’ve helped multiple clients navigate their inheritances and can lend a hand as you choose to what to do — and not to do — with yours. 

Along with Director of Estate and Financial Planning Dan Andrews, CFP®, we can also act as a guide as you decide how you would like your assets to be distributed in the future. If you’d like to discuss your wishes in advance of your estate planning meeting with your attorney, feel free to schedule your next meeting on our Meeting page. And if you’d like for us to provide some options for estate attorneys we recommend, you can contact us via chat, phone call, text — or by scheduling a time to get together in person or virtually. With unlimited meeting and consultation time included in your comprehensive services agreement, we can even join you when you meet with your attorney.

Wondering what steps you should take next?

Grab a copy of our Sudden Money Checklist as you navigate your inheritance.

Jason Speciner
jason@fpfoco.com

Jason Speciner is a CERTIFIED FINANCIAL PLANNER™ professional, an Enrolled Agent, and the founder of fee-only firm Financial Planning Fort Collins. He is also a member of the National Association of Personal Financial Advisors (NAPFA), Financial Planning Association (FPA), and XY Planning Network. Since 2004, he has served clients of all ages and backgrounds with unique experience working with members of generations X and Y. To learn more, check out Jason's blogs and see the media he's been featured in.



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ESTIMATE YOUR FEE
Your fee is determined by the complexity of your needs and situation. The primary proxy we use for complexity is your investable net worth, which is generally your total net worth, excluding your primary residence. Your investable net worth includes the value of cash, bonds, stocks, mutual funds, rental real estate, and other business or financial interests. This aligns with the holistic nature of our comprehensive services. You can use the chart below to estimate your fee based on your investable net worth. In some circumstances, your fee may be more than the minimums in the chart below.
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