Navigating an Inheritance

Navigating an Inheritance

In life, there are two guarantees: death and taxes. Unfortunately, people often do not think about what happens to their estate after they are gone, leaving behind personal items, bank accounts, investments, etc. for their loved ones to sort on their own. This can be an overwhelming task for people who have never been in that position before and are unfamiliar with the process, all while dealing with their grief. At B&C Financial Advisors, we have unfortunately seen this happen, which is why we encourage our clients to establish an estate plan, which can make things much simpler to deal with for a grieving family. In this article, we will explain some of the steps involved to help you gain an understanding of what can be expected if you receive an inheritance that is not so cut and dry.

Most people have a will in place, which outlines their final wishes. However, if they did not have all their assets in a trust, you will need to go through the probate process. Probate is the judicial process of administering the will and making sure the decedent’s wishes are being honored. Each state is a little different, but the general process is to:

  1. File the petition of administration with the circuit court in the county where the decedent lived at the time of death. The will is needed, and a personal representative will be appointed for the estate.
  2. Notify all creditors and any claims must be paid before distribution of assets from the estate.
  3. Take inventory of the estate to get a valuation. This will include all bank accounts, investments, homes, cars, artwork, etc. Sometimes this can be easy to value, such as bank accounts, but valuing certain items, such as artwork, may take a specialist to help.
  4. After a certain time, depending on the state, the claims period will end, and the estate must pay all valid claims. After this period, if a claim comes in it is considered invalid and does not need to be paid.
  5. Get a final accounting of the estate to distribute the assets per the will of the decedent. This will need to be filed with the court and approved.

One of the most common inheritances people receive is in an individual retirement account, or IRA. Depending on your relationship with the decedent, there are certain rules with respect to distributing these assets. For example, if you are a non-spouse heir, you must distribute the entire IRA by the end of the 10th year following death. This can be intimidating when you think about the taxes you will be paying if the IRA has a substantial amount of assets in it, since every dollar that is distributed becomes taxable income to you. You must then plan for these required minimum distributions (RMDs) to determine the amount and timing of the distributions based on your personal income and tax situation.

If you believe your income is going to be higher in the future, it may make sense to take more funds out of the IRA earlier. However, if you are close to retirement yourself, it may make more sense to wait until you are in retirement with a lower taxable income. Planning for these distributions is different for every individual, so what works for someone else may not apply to your own financial situation.

Another consideration to make is whether you would like to reinvest the funds that are distributed. You may find, at the time you inherit or distribute funds from the IRA, you do not need the money to cover your living expenses. If so, you could decide to transfer the assets into a taxable account (e.g. brokerage or joint account). You also have the option of paying the taxes to the IRS directly from the IRA at the time you make a distribution, or you can pay them when filing your taxes the following year.

A Roth IRA is another very common inheritance. This type of account has the same 10-year rules as a traditional inherited IRA for a non-spouse beneficiary (a spouse who inherits either type of IRA can treat the account as if it was their own). Because distributions from a Roth IRA are not a taxable event, it is usually best to keep the funds in the Roth IRA until year ten. This allows you to have tax-free growth for ten years. Again, if you do not need the funds at the time of distribution, you also have the option to move the funds to a taxable account to keep the account invested.

While death is an unfortunate part of life, it is likely you or someone you love will find themselves dealing with these types of decisions. Understanding the process and getting a team of people who can help you facilitate this is one of the best things you can do for your mental health during this emotional time. Each person’s estate is different and unique to them. Honoring your loved one’s decision and making sure the estate is distributed per their will is the best way to let their memory live on for the people who were most important to them.

Once you receive an inheritance, it is up to you to make the decisions about what you would like to do with the money. Everyone has different financial goals in their life, and making the right decisions for you with the right people on your side will make a difference in the longevity of the money and achieving your goals. Knowing these rules and the process will hopefully help alleviate some stress during an emotional time.