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You've Received an Inheritance: What Financial Questions to Consider

Photo of author, Nicole Gabriel, CFP®.
Nicole Gabriel, CFP®
Financial Strategist

When you receive an inheritance, it can trigger mixed emotions that can either freeze you into doing nothing or could even lead you down a path of financial mismanagement. Here are several questions to consider that will help you make good decisions on your way toward a good financial management with your inheritance.

WHAT ARE YOU ACTUALLY INHERITING?
Are you inheriting cash, an Individual Retirement Account (IRA), 401(k), life insurance proceeds, a brokerage account, an annuity, or even a trust? It is helpful to pause and take time to understand the nature of the investment you are inheriting, as well as its impact on your finances, your taxes, and even your own estate. If you are inheriting tax-advantaged accounts (like an IRA or 401(k)), your options will depend on if you are the spouse of the deceased or not. Please read my colleague Debbie Moses’ article “So You’re Inheriting an IRA.”

If you are inheriting a trust, it will likely be managed by a trustee like an attorney, banker or another family member or trust advisor. The trustee is the one responsible for using the trust documentation to both manage and distribute the assets held within the trust. Every trust is different, so it is important for you to understand what the trustee responsibilities are to you.

Life insurance, brokerage accounts and other financial assets have their own unique qualities which you also want to become familiar with. Life insurance, for example, may be a lump sum of cash which can be added to a savings account or invested. A brokerage account (non-IRA) could be added to an existing taxable investment account or could be used to open one.

WHAT ARE THE TAX IMPLICATIONS FROM MY INHERITANCE?
After determining what will be inherited, it is very important to consult a CPA or tax advisor. There can be Federal OR State Estate taxes that need to be paid by the estate’s executor before the estate proceeds are disbursed. Depending on the state, there may also be inheritance taxes that need to be paid by you as the beneficiary. Though McKinley Carter Wealth Services operates in 30 states, most of our clients reside in Pennsylvania, West Virginia, Maryland, or Florida. The chart below details the Estate and Inheritance Tax differences between them.

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WHAT ARE THE PITFALLS OF A WINDFALL?
You should consider your financial goals. What do you really want for the near and longer term and how can you use the inheritance as a tool to realize your goals? You may begin by increasing your emergency fund or paying off debt. Maybe an inheritance can allow you to create an investment account and develop a strategy to allow you to set goals for your investments.

An inheritance could range from $100 to millions of dollars. While it is difficult to plan for an inheritance of any size, there are several items to think about before spending the “windfall.” You should evaluate your current financial situation and financial behaviors before deploying the inheritance. Quick and early splurges might not yield good outcomes and the inability to think long-term can be detrimental as well. The idea of a bigger house may sound like a good investment, but have you considered that a bigger house comes with bigger monthly expenses that need to be added to your budget?

HOW DOES MY INHERITANCE AFFECT MY OWN ESTATE?
Receiving an inheritance is also a good reminder to review or create your own Estate Plan. An Estate Plan can allow you to determine how you want your assets distributed, but it can also be used to protect the wealth you have accumulated. An attorney or other trusted advisor can help you determine what planning should occur.

Working through your estate plan also means reviewing and naming beneficiaries for your accounts. If you received an inheritance, you were likely chosen as someone’s beneficiary. It is important to have beneficiaries or the Transfer on Death (TOD) designation listed on your investment accounts so your executor can distribute the assets without going through the probate process. Another part of the estate planning process is the writing of a will or naming a Power of Attorney. Estate Planning may not be the most enjoyable part of this process, but it is an important part of protecting your wealth and your family.

No matter how large or small an inheritance it, these are several tips to help you navigate it alongside your trusted advisors. Thinking about these, even before an inheritance is received, can help you make positive financial decisions now and in the future.

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