How to Make the Most of Your Inheritance?

Q&A: How can I make the most of my inheritance? 

Most heirs face many complex decisions — and potential tax consequences. These insights can help you avoid common mistakes and make starter choices.

AN INHERITANCE CAN SEEM LIKE a mixed blessing, coming as it often does after the loss of a loved one. At such an emotional time, it can be difficult to think through what you need to do to manage the gift. But even if your parents decide to give you your inheritance, or a portion of it, while they’re still living — as many parents increasingly prefer to do — you’ll likely have many questions, says Kevin Hindman, managing director and wealth strategies executive, Bank of America Private Bank. 

You might want to schedule a conversation with a financial advisor and your personal tax professional in advance to discuss the potential tax consequences and how the gift could help you pursue your goals. It can also make sense to talk with your parents about their hopes for your financial future. Read the insights below for a better sense of how to prepare for the many issues heirs can face.

Q: How do I begin a conversation with my parents about their estate plans? 

A: It’s not necessary to ask how much money your parents might leave you. Start the conversation by asking about their values and what wealth means to them. That can lead to productive conversations about the role an inheritance could play in your financial future and what your parents’ expectations might be. This sort of conversation also provides you with the opportunity to share your preferences and priorities. For instance, if there’s a family business, or even a family vacation home, and you have no interest in owning either, be upfront about that. When everyone understands the expectations, the outcomes tend to be better for everyone. 

Q: I just found out I’m receiving an inheritance. How quickly do I need to make decisions?

A: You’ll likely have some time before you receive the funds; depending on the complexity of the estate, the probate process, if applicable, generally takes at least six months to a year. That’s often for the best. Too often beneficiaries make large purchases or sweeping decisions that they later regret. Even paying off debt right away may not be in your best interests, says Hindman. “Does it make sense to pay off a mortgage at a rate below 3%? You might do better than a 3% return elsewhere,” he notes.

Instead, consider setting up a meeting with your advisor to discuss your competing goals and how you could manage your newfound wealth to help you pursue them. Bank of America Wealth Strategist Victor Diune suggests looking at four buckets — spending needs, short-term goals, long-term goals and philanthropy. “How you allocate your inheritance to these buckets depends on your situation,” he says. If you have young children, a portion could go toward college costs in the long-term bucket. But if you’re looking at renovating your home or relocating, you’ll probably want to put those funds into a short-term bucket and make sure they’re easily available. 

Q: What if my inheritance isn’t in cash? 

A: Most inheritances aren’t, says Hindman. You might be named the beneficiary of a retirement account – or you could inherit the family home, for instance.  If you’ve inherited a tax-deferred account like an IRA or a 401(k) account and you’re a non-spouse designated beneficiary,¹ you’ll have 10 years after the death of the original account owner in which to fully liquidate the account (depending on your age relative to the original account owner and certain other circumstances). The rules are complex, and you’ll want to consult with your tax professional to help you understand them and decide on a strategy to address them. 

“Things can get more complicated when converting real assets such as a family home or business into cash, especially when multiple beneficiaries are involved,” notes Hindman. If there are disputes over a will, it could take years for the issues to be resolved. In the best-case scenario, parents have worked with their advisor and estate attorney to construct a will or trust in such a way that its provisions account for the beneficiaries’ desires — for instance, which child wants to keep the family home or work in the family business. 

Q: How could my inheritance affect my taxes?

A: For tax purposes, inheritance generally isn’t considered income, but there are some exceptions. If you inherit certain tax-deferred accounts like a traditional IRA or 401(k) account, you’ll pay taxes on your withdrawals, including RMDs, as ordinary income at whatever your rate is.

When it comes to taxable accounts and other assets like real estate, there’s the possibility you’ll owe no income tax, because the cost basis of the asset gets stepped up (or down) to current fair market value upon its owner’s death, thereby wiping out any taxable capital gains on appreciated assets, says Hindman. Keep in mind that if you inherit an asset that provides income — say, a trust that pays out annually — it may put you in a higher marginal tax bracket. 

Q: Could my inheritance require changes to my own estate plan?

A: Whenever your net worth changes, you should update or revise your estate plan, says Diune. You may need to consider how to protect certain newly acquired assets — for instance, a family home or business that’s been passed down to you that you want someday to go to your children. 

“Ask yourself, if something happens to you, how will your assets flow to the people you care about?” he adds. A trust might be one way to accomplish that aim.  To learn more, you might want to engage with an advisor about ways you might want to use your inheritance to further your own legacy — and help make your beneficiaries’ future more secure.

¹An eligible designated beneficiary (EDB) is a surviving spouse, disabled or chronically ill individual, an individual who is not more than 10 years younger than the decedent, or a child of the account owner who has not reached age 21. Distribution rules differ based on the date of death, whether or not the beneficiary is an EDB, and whether or not the original account owner died before or after their required beginning date for Required Minimum Distributions. 

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For more information, contact Merrill Lynch Financial Advisor Don P. Martone of the Hughes Landing office at (281) 882-4818 

Merrill Lynch Wealth Management - Don P. Martone, CFP®, CPWA®, ChFC®, CLU®

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