What do I need to know about inheritance?

Inheritance can be a sensitive subject, and in some cases, it can be overwhelming. It not only comes at a time fraught with emotion and, perhaps, shock, the legal and tax ramifications are not always straightforward. But there are ways you can prepare and key factors to consider, both before and after a benefactor passes.  “To make the most of an inheritance, it’s essential to engage your advisors before you receive the gift,” says Lisa Wells, a Market Trust Executive with Bank of America Private Bank. “Don’t wait until the decisions are urgent. Discuss in advance the tax consequences and how the gift could help you pursue your goals.”

The answers to the questions below give a good sense of how to consider the many issues heirs can face.

A: It is not easy for a lot of parents to have a conversation about wealth with their children.  Yet open communication among family members about estate planning is key to a successful wealth transfer. “Start these financial conversations with parents or other benefactors by focusing on their goals about their wealth and legacy, not about their statement of net worth,” says Wells.  Understanding the family values around money is just as important as sharing the details of the inheritance.  When a heirs-to-be elevate the conversation about wealth with their parents beyond the numbers, it demonstrates a level of maturity to hopefully convince parents to become more comfortable sharing the important information.  Open lines of communication also makes family discord less likely.

A: Depending on the size of the inheritance and complexity of the estate, you may or may not have time to make any decisions before you receive the funds.  “If you are receiving funds right away, we encourage you to make sure the inheritance proceeds are held in safe, short-term, interest-earning vehicles until you have given yourself adequate time to make the important longer-term decisions,” says Rocky Fittizzi, managing director and senior wealth strategy advisor with Bank of America Private Bank.  If the probate process or the complexity of the estate holds up the inheritance for a period, that actually provides a cushion of time to make those decisions. “We have seen too many cases where large initial spending decisions are impulsively made that individuals regret in the future” notes Fittizzi. 

Wells adds, “Our first and most important recommendation is that individuals quickly assemble their professional team.”  That includes tax advisors and legal counsel to work alongside your private banker or financial advisor. The combined skill sets can help address the management of legal and income tax issues related to the inheritance, while creating a financial plan that balances lifestyle and cash flow with their goals and objectives for the rest of their lives.

A: Understanding the true nature of an inheritance takes time.  Most inheritances are not in cash and it often takes some time to get through the probate process and inheritance for a complex estate.  Typically, assets that pass via beneficiary designations or jointly held assets can be accessed quickly.  These include retirement accounts and life insurance policies.  There are specific rules with the inheritance of retirement accounts that your financial team can help talk you through as a beneficiary of these plans.

There are other assets that take more time to sort through since they involve more complexity.  These include family businesses and real estate when there are multiple beneficiaries.  Your financial team can help you to decide the best strategy for each specific inherited asset with the hope that benefactors have constructed an estate plan that smoothly transitions to its beneficiaries.

A: For tax purposes, inheritance generally isn’t considered income, but there are some exceptions. If you inherit certain tax-deferred accounts like a traditional IRA or 401(k) account, you’ll pay taxes on your withdrawals, including required minimum distributions, as ordinary income at whatever your rate is.

When it comes to investment accounts and other assets like real estate, there’s the possibility you’ll owe no income tax, because the cost basis of the asset gets stepped up (or down) to current fair market value upon its owner’s death, thereby eliminating any taxable capital gains on appreciated assets. Keep in mind that if you inherit an asset that provides income — say, a trust that pays out annually — it may put you in a higher marginal tax bracket.

A: Whenever your personal or financial situation changes, you should update or revise your estate plan. From a personal standpoint, this could be a result of specific events occurring in your life, like additional children, divorce, loss of loved ones named in documents, change of residence to a different state, or simply a change to preferred beneficiaries or charities.  It can also be that your feelings towards fiduciaries (executors and trustees) or guardians for children under the age of majority have changed and your documents should reflect those changes.

From a financial standpoint, you have newly acquired assets, so you should speak to your advisory team on how to best protect them and minimize potential estate taxes.  It is also an opportune time to talk to your advisor about how you might want to use your inheritance to further your own legacy, make your beneficiaries’ future more secure, and how they help your heirs with respect to their financial education. “Being financially literate, especially of their own family situation, makes heirs more likely to be good stewards of their inheritance,” notes Fittizzi.

Bank of America’s Financial Empowerment program is a hands-on financial education curriculum that young adults can access in partnership with their Bank of America team.