If you receive a large inheritance, you may not know immediately what you want to do with it. This kind of gift can be life changing. It could help you erase debts, build a safety net, start a business, start a family, live life on your own terms, help your children with one of their dreams … so many possibilities. But whatever you ultimately choose to do, doing it with care can help set you up for success.
An inheritance, or any pool of assets, is just a source of potential. What you can achieve with it depends on how clearly you set your goals and how well you can create a plan for reaching them. That’s understandable enough, when you think about it, but it can be a challenging task to face.
Add to that the specific rules around inheritances and the multiple kinds of assets that can be part of an estate, and it may feel overwhelming. Let us help guide you through some effective first steps.
First, Take Your Time
This is important to remember. To get the most benefit from your inheritance, it’s worth spending all the time you need.
Nobody really wants to be part of one of those storylines about the grown children who inherit the family estate and squander it away quickly. While a story about those children reviewing their accounts and consulting with their advisors might not be exciting to watch, it would be the plot line with the best ending.
If the inheritance is anticipated, you may start your planning ahead of time. But remember that many things — health issues, fraud, a bad market — can affect the estate before you inherit so it’s best not to count on an inheritance as a guaranteed way to fund your personal aspirations.
Assess Your Financial Position and Hire a Financial Professional
No matter what you want to do with your inheritance, start off with a clear view of your pre-inheritance financial picture. It’s always easier to reach a destination if you know where you’re starting off.
Collect information on all your assets, debts and financial activities. If you don’t already have an effective system for organizing this in one place, this is a great time to create one.
In collecting your financial data, what you really want to know is what it means for your present and future. You want answers to questions like:
Is your level of debt reasonable for your income and lifestyle?
Do you have enough in an emergency fund to survive a negative event, like a job loss?
How much would you have available to invest in a dream opportunity if it came along?
Do you have housing, retirement, and education funding covered?
This can be a good time to hire a financial professional. Someone with experience helping individuals manage their wealth can help you understand exactly where you are on your financial journey and what it can take to get to where you want to be.
Your financial advisor can help you understand how to flesh out your goals and bring them to life, whether that’s through debt reduction, emergency savings, or creating an “opportunity” fund — a cache of liquid assets that can allow you to take advantage of special opportunities that may come your way.
It may also be important to you and your family to give back. Having the resources to do this is a privilege but may also be viewed by some as a responsibility. Look for a financial advisor who is experienced in navigating the options in charitable giving and serving the best interests of both donors and charities.
Understanding the Difference Between Estate Tax vs Inheritance Tax
The first question people tend to ask when they receive or are expecting a large inheritance is “Do you pay taxes on inheritance?” Well, yes and no. As the receiver of the inheritance, you may have to pay inheritance taxes. But the amount you receive may also be affected if the estate is hit with a tax bill. Let’s look at the difference between estate and inheritance taxes and when each applies.
What Are Estate Taxes?
Estate taxes are levied by the Federal Government and by several states. Generally, estate taxes are paid by a deceased’s estate before the assets go to the heirs. The federal estate tax is collected only on amounts in excess of the current federal estate tax exemption amount. This is the total dollar amount that individuals can transfer either during their lifetime or at death without paying taxes. For 2024, the exemption amount is $13.61 million per individual or $27.22 million per married couple.
(Note that this historically high exemption amount is not necessarily permanent. It is scheduled to be reduced to approximately $6.5 to $7 million per individual on December 31, 2025, unless Congress acts to extend it.)
Above the exemption amount, the tax is progressive, meaning the tax rate increases with the value of the assets transferred. The top marginal rate, on taxable assets above $1 million, is currently 40%.
The District of Columbia and 12 states — Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont and Washington — also collect their own estate taxes. Exemption thresholds and tax rates vary from state to state but are generally much lower than the federal amount, so it’s a good idea to consult a tax advisor to see how you could be affected.
What Is Inheritance Tax?
Inheritance taxes are separate from estate taxes and are charged to certain recipients of assets from a decedent. Although you are personally responsible for inheritance taxes where they are levied, the good news is that there is no federal inheritance tax and only six states impose their own — Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Iowa’s inheritance tax will no longer apply for any deaths on or after January 1, 2025.
Kentucky and New Jersey have the highest top inheritance tax rate of 16%.
States generally levy a higher inheritance tax on familial relationships that are more distant, which is why surviving spouses and children are often exempt from such taxes. You are more likely to owe inheritance taxes if you are a niece, nephew, cousin or friend of the decedent.
What to Do When Inheriting Real Estate
Often, a large inheritance will include various asset types less liquid than cash. Real estate is a common example.
You’ll first need to know exactly what you have. Family members or the estate executor may have some information. Are there outstanding loans or liens against the property? What is the condition of the property? And, of course, what is the value of the property? You may need to consult a real estate professional to get all the answers.
Armed with information, you can decide what to do — sell, rent or lease, or keep the property for personal use. If you inherited the property jointly with other family members, these decisions become more complicated. Professional advice can be especially helpful in coming up with a solution that’s fair and acceptable to everyone.
When making your choice, keep in mind:
The type of property (vacation home, condo building, retail, restaurant, office, factory, etc.)
Local rental/lease rates
Conditions in the current real estate market
The growth potential of the property
Maintenance and/or holding costs
What to Do When Inheriting Stocks
The first thing to do when you inherit stocks is to review the portfolio with your financial advisor. You’ll want to understand the risk profile. Which positions fit well (or poorly) with your own goals, timeline and risk tolerance? Will the new equities integrate seamlessly into your current investment strategy, or will you need to rebalance industries, regions or categories?
If you want to sell some or all the stock, inheritance can have beneficial tax consequences. The “cost basis” of a stock — the base price your capital gains are calculated from — is established on the date you buy a stock or are gifted one by a living donor. In other words, if you buy or are gifted a unit of stock worth $100 and you later sell it for $120, you’ve earned $20 in capital gains, and you owe taxes on that amount.
However, when you inherit stocks, their cost basis is reset to their fair market value on the day of the benefactor’s death. This is called the “stepped up cost basis.” You will not owe tax on any gains that happened while the stock was in the benefactor’s hands, only after the date of death. So, if that same stock is worth $120 when you inherit it and you sell it at that price, you owe no capital gains tax.
This cost basis adjustment can be a significant benefit, especially for high-growth stocks. Imagine if you inherit Amazon stock that was purchased in the year 2000 for $10,000. That same stock would be worth close to a half million dollars today and you wouldn’t owe a penny of the potential $100,000 in capital gains tax that would have been due if the original purchaser sold the stock.
Your financial advisor should be able to help you determine if you should leave inherited stocks where they currently are or move them into your own account. Your options will depend on how the original portfolio was structured and where and how it was held.
What to Do When Inheriting IRAs and 401(k)s
Inherited IRAs and 401(k)s can be especially complicated. The tax rules vary depending on whether you are inheriting from a spouse or someone else and on the type of IRA: traditional or Roth. Based on these factors, you may have different options for managing the account and withdrawing money.
You won’t owe tax on the amount you inherit if you move the funds to an inherited IRA, but you will be taxed when you take distributions from a traditional IRA, just as the original owner would have been. In the case of Roth IRAs, your withdrawals are typically tax-free, but other rules can affect the taxation of distributions.
Since the specific rules for inherited IRAs and 401(k)s can depend on how old the account holder was when you inherited, how old you are, the plan’s specific distribution rules, and any changes to federal law affecting retirement accounts, consulting with an advisor on how to handle these accounts can help you avoid excess taxes or penalties and optimize your return.
What to Do When Inheriting Through a Trust
When you inherit money and assets through a trust, the terms of the trust determine how and when you receive distributions. So, you should connect with the trustee — the person named to manage the trust — and to read the trust document carefully.
Trustees can be family members, friends or advisors, trust officers, attorneys or bankers — anyone the deceased trusted to carry out their wishes. The trust document should clearly outline the trustee’s duties, how the trust assets will be managed, and how and when you’ll receive income or assets from the trust.
Review the trust terms with an estate attorney and/or a financial advisor to ensure you understand fully how they could impact your plans.
Last, Take Your Time
Managing a large inheritance is just too important to your future to rush through. There’s a lot to think about.
You may also have noticed a recurring theme throughout this article: Talk to an advisor. There’s a lot to talk about. You don’t have to go it alone. And any successful person will tell you that the best results come from getting the best advice.
We’re here to listen to you about where you want to go and help you find the best path there, pushing through the real-world tangle of existing laws and market conditions to find your financial freedom.
Investment advisory services offered through CWM, LLC, an SEC Registered Investment Advisor. Carson Partners, a division of CWM, LLC, is a nationwide partnership of advisors.
Carson Wealth: 6910 South Cimarron Rd, Suite #210, Las Vegas NV 89113