What to do with an inheritance.

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What to do with an inheritance.

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Have you received an inheritance recently, or do you expect one in the future? Was it expected or unexpected? Was it more or less than you originally thought, or was it a total surprise? Are you wondering what to do with an inheritance?

Inheritances are usually a blessing bestowed upon lucky people who unfortunately lost a loved one or a long lost relative. What that inheritance can mean for your life and how it can help you varies greatly depending on whether you blow through it quickly or whether you structure it so that it compounds, grows, and lasts for the long-term.Have you received an inheritance recently, or do you expect one in the future? Was it expected or unexpected? Was it more or less than you originally thought, or was it a total surprise? Are you wondering what to do with an inheritance?

There are many factors to consider.

  1. What did you inherit? Did you inherit a house, inherit a car, inherit an investment portfolio, inherit a savings account? If you inherited a house, then you could just put it up for sale. And then the question becomes what to do with the proceeds.
  2. Taxes on inheritances – There is a myriad of tax consequences depending on what you inherited and how it was structured. Was it a taxable investment account? Then a step-up in basis applies. Was it an IRA? Different tax rules apply then. Read on for more details.
  3. Don’t blow through it. Think long-term and about what you want to achieve. Here are some ideas:
    • Saving it for your kid’s college fund if you already have your emergency fund in place
    • Paying off high interest debt, like credit card debt
    • Paying off your mortgage– although this might not be a good idea depending on your interest rate. Read below for more information.
    • Enjoy a bit of it, but not all of it.
    • Invest for your goals, time horizon, and risk tolerance, not that of the deceased/original owner.


Taxes on an inheritance

Taxes on an inheritance differ depending on what was inherited. Most inherited assets, such as investments and property, receive a step-up in basis, explained below.  Depending on the type of investment account and your choice on distributions, the tax implications vary. Furthermore, if the estate is above a certain level, then the federal estate tax (aka death taxes) can apply, too.


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Selling an inherited house

Are you selling an inherited house? You will receive a step-up in basis at the date of death. For example, say the original owner paid $250,000 for the house. On the date of death, the house is worth $450,000. Even though the owner’s basis in the house is $250,000, you will have a step-up in basis at $450,000. That means you have $0 in capital gains vs. a $200,000 capital gain, which could be taxable.


Paying off your mortgage with an inheritance


Have you thought about paying off your mortgage with your inheritance? It might not seem like a bad idea, but there are things to consider. If you already have a low interest rate on your mortgage, you might consider investing the inheritance with the idea that over the long term it could earn more than the interest rate on the mortgage. Another benefit of keeping your mortgage is that mortgage interest is tax-deductible.

It makes more sense to pay off debt that has higher interest rates than a mortgage, such as credit card debt or student loan debt. You should consult a financial advisor for guidance.


Inheriting a brokerage account

Inheriting stocks and an investment account, assuming it is taxable, also allows you to receive a step-up in basis, just like the inherited house example. Once the assets are titled in your name, it is important to have the account titled TOD with a named beneficiary. This way, the investment account would avoid probate if you died, and go directly to your beneficiary. It’s also important to restructure the portfolio so it addresses your needs, goals, risk tolerance, and time horizon – and not that of the deceased.


Inheriting a Roth IRA

If you inherit a Roth IRA, you will most likely have 10 years to take distributions from it. The exceptions are

  1. Spouses
  2. Minor children of the deceased
  3. Those who are disabled or chronically ill
  4. Those who are not more than 10 years younger than the deceased, such as a sibling.

Spouses have several options to choose from, including treating the Roth IRA as their own.

Roth IRAs are considered part of the owner’s taxable estate. Therefore the federal estate tax would apply if the estate is over the limit set by the IRS.


Inheriting a Traditional IRA

If you inherit a Traditional IRA and you take a full distribution from it, then you will be taxed at ordinary income rates on that entire distribution to you. The full distribution might bump you up to the next tax bracket, too. But, you do not have to take a full distribution. You can spread it out thereby reducing your overall tax liability. The 10-year rule explained in the Roth IRA section applies here, too. The difference is that the distributions from the Roth IRA are not taxable while the distributions from the Traditional IRA are taxable.


Inheriting a 401(k)

Have you inherited a 401k from a parent, spouse, or friend?  

If you have inherited a 401K, then the options available to you depend on whether you are the spouse of the deceased owner, and how old both of you were when the deceased owner died.

Regardless of the ages, a spouse can roll the funds over to his or her own IRA, called a spousal IRA. This is the most common option. The full list of options available depending on all factors are:

  1. Spousal IRA
  2. Inherited IRA using your own life expectancy or the 10-year rule
  3. Leaving it in the 401k
  4. Taking a lump sum distribution

Keep in mind:

Creditor Protection – Inherited IRAs do not offer the same protection from creditors in the event of bankruptcy and lawsuits. Regular IRAs and 401Ks do offer better creditor protection.

Beneficiaries – If funds are left inside the 401k, then the ability to name your own beneficiaries might be limited. Naming your own beneficiaries is allowed in Traditional, Roth, Inherited, and Spousal IRAs.


Interested in meeting with a financial professional to discuss how to invest your inheritance? Contact us here or Meet our team here.

Want to know which investment type carries the least risk? Read about it here.

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