When someone receives an inheritance, it is often the first time they’ve received a large chunk of money all at once. It’s also often the impetus to reach out to a financial advisor.
Unfortunately, there’s often a fair amount of grief associated with receiving the money, as it’s often from a parent or a spouse or other very close relative. We suggest avoiding making major financial choices immediately after a loss; the emotional fog of grief is not the ideal state of mind for big decisions. Instead, give yourself some breathing room, even if that means leaving it in cash for three to six months. That will give you some time to make the right choice.
Tax and Inheritance: Brokerage Accounts Vs. IRAs
The first step is to assess what you inherited. The specific framework for managing inherited wealth relies entirely on whether it arrived as a house, cash, life insurance or a retirement account. When inheriting a standard brokerage account from a parent or grandparent, the financial rules typically adjust the investment’s cost basis to its current market value. Basis is essentially what you bought something for, and when you inherit, you frequently receive a step up in basis. For example, if your parent had a brokerage account worth $100,000, and then it grew to $150,000, a child inheriting it doesn’t have to pay capital gains tax on that $50,000 in growth. Instead, they received a step up in basis to the $150,000.
However, traditional IRA’s don’t share the same tax freedom as brokerage accounts, generally requiring you to pull all the money out within a decade. The person inheriting will have to pay tax on the money at their ordinary income tax rate instead of at a capital gains rate. It’s often worth consulting with a financial advisor to make sure you meet the rules associated with inheriting IRA’s.
Related: How Much Life Insurance Should I Have?
What Goals Can Your Inheritance Help You Meet?
In addition, establishing a relationship with a financial professional before the inheritance passes can provide a third party to help you navigate your finances through the fog of grief. Consider creating buckets to fund short, medium, and long-term goals. It’s okay to spend some on a short-term goal. To avoid swinging between guilt and overspending, allocating a small percentage towards a meaningful goal or personal enjoyment is a healthy way to honor the giver. Look at your situation and think, how can I find something that brings me joy but also honors the person who left me the inheritance?
Inheritance Can Fund Your Own Retirement
Before helping others financially, make sure your own future is secure. You should consider prioritizing building an emergency fund, paying down high-interest debt, and saving adequately for retirement. While it’s natural to want to support your children or loved ones, protecting your long-term financial stability should come first.
Inheritance Can Secure Your Legacy
Once your own financial foundation is in place, consider the legacy you hope to leave behind. Whether your goal is to provide an inheritance, fund a grandchild’s education, support a favorite charity, or pass along family assets, thoughtful long-term planning can help ensure your wishes are carried out while keeping your overall financial goals on track.
Finally, consider what outcome would make you look back and say, “This money was well spent.”
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