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Before you do anything with any inheritance, take a deep breath. This is likely an emotional time for you, which makes it difficult to make big decisions. You have a unique opportunity to do something wonderful for you or the people you love with the gift, so take some time to think about it.
There are many kinds of inheritances. You can receive cash, a retirement account such as a 401(k) or an IRA, a house or other property, jewelry, cars, antiques, and almost anything else. What you can do with your inheritance depends on what you’ve inherited, though there are a few things that apply to all inheritance situations. Read more about what to do with an inheritance.
If you are reading this because a loved one recently passed away, we are deeply sorry for your loss. Our sympathies go out to you and those affected by their passing.
It’s a good idea to let the inheritance sit before you make any big moves, but there are still a few things you can and should do right away.
If you inherited money, take time to develop a preliminary plan before you make any big moves.
Start by considering your current situation. Total up all your debts, including credit cards and personal loans, car loans, student loans, and mortgages. Take note of the interest rate you pay for each, so that you know which loans are costing you the most. Next, consider your current savings situation. This includes your emergency savings, investments, and retirement accounts. Finally, look ahead at your future. Are you expecting a baby, or have children who will need help paying for college? Is your job secure? Are you nearing retirement?
Next, consider your options. While almost anything is possible, here are seven of the most common things people do with inheritance money:
It’s important to remember that you don’t have to use all the money on just one thing. You can divide it up and make choices based on your priorities.
Once you’ve developed your preliminary plan, it's recommended to meet with a financial professional to review and prioritize your list. Every person’s situation is unique, but the goal is to do something that has a positive return for you. Here are some possible ways to use a cash inheritance:
Even if you receive a modest inheritance—you have many options. One idea is to fund an emergency savings account. Experts recommend that you have six months of living expense set aside for emergencies, and $20,000 would put you well on the way to this goal. Another option is to pay off credit card or other debt, which helps you save money on interest.
If you receive a bigger inheritance, first consider the recommendations above—fund an emergency savings account or pay off credit cards and loans. You can also use a portion of the money to pay off all or part of your mortgage or pay down student loan debt. When making these choices, be sure to consider the interest rate you’re paying to determine which move will save you most in interest. Another idea is to set aside some of the money in a retirement fund such as an IRA. For example, if you qualify for a Roth IRA, consider using some of the money to fully fund it. The annual funding limit for a Roth in 2020 is $6,000 ($7,000 if you're age 50 or older).
If you receive a large inheritance and have worked your way through the suggestions above and paid off all debts and even your mortgage, look to your retirement fund next. Even if you’ve maxed out your tax-deductible IRA contributions, you may want to consider taxable investments that can help fund your golden years. You could also use some of the money to remodel your house or buy a vacation property.
Sometimes, people who inherit a large sum of money decide to invest it and preserve the principal, then use the proceeds to fund other expenditures. This allows you to keep the original inheritance intact and pass it on to your heirs while still allowing you to use some of the money. And certainly, consider using some of the money to pay a professional to develop an estate plan that will protect the money if something happens to you.
Maybe. Most experts recommend that you establish an emergency savings fund and pay off other higher-interest consumer debt such as credit cards or auto loans before you do anything else. Certainly, if you have a second mortgage, this would also be a high priority to pay off. However, if your mortgage has a low interest rate, and if you have inadequate retirement savings, you may want to consider investing in an IRA before you pay down your mortgage. A financial professional can help you evaluate your options.
If you have been gifted any antiques or a vintage car, it’s a good idea to start by having them appraised, so you know exactly what you’re looking at in terms of value. Be sure to also keep things that can help corroborate the item’s authenticity and history, such as original purchase receipts or other documents that can be useful when you have the item appraised. Use a professional appraiser; find one from the International Society of Appraisers, the Appraisers Association of America, or the American Society of Appraisers. The appraisal will allow you to adequately insure the items and will help you decide whether you want to keep or sell them.
You will need to get the title of the car, boat, RV, or other vehicle transferred to you. If it was specifically gifted to you in a will, then the executor can put your name on the title. Otherwise, the matter must be handled in probate, and you’ll need to get certified documents before you can transfer the title. You’ll then need to get the vehicle licensed and registered in your state. While you won’t need to pay a sales tax, you may have to pay property or use tax, depending on where it is registered. If you’d then like to sell it, you can, but you must have the title in your name before you can do so. Be sure to keep track of all paperwork.
If you inherit a house or other property, you have several options: sell it, keep it as a rental property, or live in it yourself. If you decide to sell it, you’ll only pay taxes on what’s known as the “stepped-up basis.” This means you only pay capital gains taxes on the difference in value between when the person died and when you sold it. If you want to avoid capital gains tax, you must live in the house for at least two years before selling it. This allows you to exclude $250,000 ($500,000 for a married couple) from the gain. You cannot have claimed the home sale exclusion in the past two years. If you keep the property and rent it out, you will only need to pay tax on the rental income itself.
Because the rules here vary by the type of investment account you inherit, this is where an financial professional can really add value. An inherited investment may come with requirements in terms of how it can be sold, or it may have limitations on the timing of any distributions. For example, if you inherit an IRA, it must be transferred into an Inherited IRA in your name which has specific distribution rules. If you inherit a 401(k), you may want to consider rolling the money into your own tax-advantaged retirement account. This delays distributions and taxes until you take the money out during your retirement. But be mindful of how the new investments impact your own asset allocation. You want to avoid having too much of your investment weighted in one specific stock, for example. And if you inherit a Roth IRA, how you can use the money may depend on how long the original owner funded it.
The implications of selling taxable investments are like those for selling property in terms of the “stepped-up” rule. If you plan to use the inherited investment for a short-term goal—to pay off your mortgage, student loans, or credit card debt—it would be best to talk with a financial professional before making any sales or trades. They can help you through these complicated options and guide you toward a solution that makes the best sense for you.
There are four types of taxes that impact an inheritance:
This tax is taken off the top; it is assessed on the total value of the money and property in the estate and is paid to the government before anything is given away. An estate tax is only assessed if the total value is above a certain amount, and that value is based on the fair market value of the item on the date of the person’s death. If there is an outstanding debt on an item—a mortgage on a house for example—this is deducted from the overall value of the taxable estate. In 2020, the federal estate tax is assessed for estates worth more than $11.58 million for singles, $23.16 million for married couples. As of 2020, there are 12 states plus the District of Columbia who also have an estate tax.
Unlike the estate tax, which is paid before any items are given away, you as the beneficiary pay an inheritance tax, not the estate. As of 2020, an inheritance tax only applies in six states: Iowa, Nebraska, Pennsylvania, New Jersey, Maryland and Kentucky. There are many exemptions, for spouses, children, grandchildren, and other dependents. However, if a distant relative or friend in one of these six states leaves you something, be sure to check with a tax professional to see if you will owe inheritance tax.
A capital gains tax will be assessed if the value of the item you inherited increases between the time the person died and the time you sell it. For example, let’s say you inherited a house worth $350,000 and you kept it for several years. If you then sell the house for $500,000, you will owe capital gains tax on the $150,000 gain in value. If you sold the house for $350,000, you would owe no tax.
If you inherit something that you then use to make money—a home that you rent out, for example—then you must pay tax on the rental income, even if you paid no tax when you received the home. And if you later sell the house and its value has increased, as described above, you will also owe capital gains tax on the increase in value of the asset.
Inheritances can certainly be complicated. This is one time where it really helps to have a relationship with a financial professional. Look for someone who will help you identify and understand your options and help you make good decisions about what to do with your inheritance.
If you've received a financial inheritance—money, stocks, bonds, mutual funds, or other investments—and you're interested in growing your inheritance for retirement or a college savings plan, an Alaska USA Financial Planning and Investment Services financial professional can assist you with developing a customized strategy that will put your inheritance to work for you. Schedule a complimentary, no-obligation consultation with us today.
Representatives are registered, securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, D/B/A Alaska USA Financial Planning & Investment Services, which is not an affiliate of the credit union. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution. CUNA Brokerage Services, Inc. is a registered broker/dealer in all fifty States of the United States of America. #FR-3307225.1-1020-1122 Exp. 11/28/2022
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