We are in the midst of the greatest intergenerational transfer of wealth in history. Financial services research firm Cerulli Associates estimates that nearly 45 million U.S. households will transfer over $68 trillion in wealth over the next 25 years.
If you are the recipient of an inheritance, how should you adjust your financial plan? Our discussion below assumes the inheritance is not received from your spouse.
While everyone’s situation is different, it’s best not to adjust your financial planning on the expectation of receiving an inheritance. While it might seem likely that you will receive something from parents or perhaps other relatives, things can change over time. Families can have a falling out, or the person from whom you were expecting the inheritance might hit financial troubles that deplete their wealth.
It’s easy to overestimate the size of an expected inheritance as well. Data from the Federal Reserve indicates that about 50% of all inheritances amount to $50,000 or less. About 30% are in the $50,000 - $250,000 range. Roughly 2% of all inheritances are in excess of $1 million.
In all cases when a client receives an inheritance we help them look at how this money fits into their financial plan. This will depend upon the size of the inheritance and the state of their financial situation.
Regardless of the size of the inheritance, it makes sense to look for areas of your financial situation where the money can be best applied. These might include:
Depending upon the size and nature of the inheritance, one or more of these areas might be addressed with the inheritance.
The form in which the inheritance is received may dictate some planning on your part before you put the money to use. If the inheritance is received as cash, that’s pretty easy to deal with.
A cash inheritance might come in the form of a life insurance death benefit from a policy in which you were a beneficiary. Or you might inherit the balance in a bank account. However, this is not always the case.
Inheritances can come to heirs in a variety of ways. This can include securities such as shares of individual stocks, ETFs and mutual funds. It could take the form of real estate, art and collectibles or an interest in a privately held business.
The inheritance might come in the form of the deceased’s IRA or 401(k) account. With the advent of the SECURE Act at the beginning of 2020, the rules surrounding inherited IRA accounts for most non-spousal beneficiaries changed drastically. These beneficiaries are now required to withdraw the entire account balance within a ten year period.
Depending on the nature of the assets inherited, there may be tax or liquidity issues to deal with.
In the case of publicly traded securities, they can generally be sold any day the markets are open. With these assets, you may receive a step-up in basis, meaning that your cost basis will be the market value on the date of death, not the deceased’s original cost basis. In the case of highly appreciated stocks, ETFs or mutual funds this can save a huge amount in capital gains taxes if you sell the shares.
Real estate can also experience a step-up in basis in some cases as well. Assets like real estate, art, collectibles and others will not be as liquid as publicly traded securities. Besides the potential for a longer time horizon to sell these assets, they may or may not bring in the amount of money you are hoping for.
In the case of an interest in a privately held business, how you proceed will depend upon whether you are or would like to be involved in the business or whether you are looking to sell the business interest to other owners of the business or to an outside third party.
Taxes can also come into play in some cases. With the federal estate tax at $11.7 million for 2021, not many of our clients have to worry about this tax. However, there may estate taxes at the state level depending upon where you live.
Regardless of the size of the inheritance, it's important to make a plan for the money once it's available to you to use.
When we advise our clients on how to integrate money from an inheritance into their financial plan we look at a number of factors.
First we start with the size of the inheritance. If it is smaller, say in the $50,000 range, we might look at one or two targeted uses. This may be to help pay for their children’s college education, to pay off a debt or add to their investment portfolio.
For a larger inheritance, we suggest that clients focus on investing the major portion of this money for the longer-term. This often means incorporating this money into their investment strategy as part of their portfolio.
We may suggest using some to cover college costs for their kids or grandchildren. In some cases we may suggest using a portion to retire the remainder of their mortgage, especially if the client is nearing retirement.
We always want to be sure our clients have a sufficient emergency fund, so we may suggest that some of the inheritance be earmarked for this purpose.
Especially with a larger inheritance, it's OK to use some of it to buy something you want. Perhaps that’s a sports car. Maybe this is funding you need to take that around the world trip you’ve always dreamed of.
This type of expenditure is fine with a portion of the money, but overall we advocate that our clients incorporate the money from an inheritance into their financial plan to ensure they are able to achieve their goals, whether that’s retirement or something else.
If you are looking for a fee-only fiduciary financial advisor who will always put your interest first, please give us a call to discuss an inheritance or any other financial issues. We are here to help.
Bill Canty, CFP®, CPA
Maureen Walsh, EA, Investment Advisor Rep.
Ed Canty, CFP®
Tina Alteri, CPA, Tax Advisor
Joe Canty, Investment Advisor Rep.