If you’ve found yourself on the receiving end of an inheritance, you know that it can be a difficult situation.
Beyond the emotional impact of sifting through your loved one’s belongings, you might also be dealing with different accounts, asset types, and investments. All of these things can be very time consuming and the different tax consequences of each asset class can cause a lot of confusion.
In this two-part series, we’re going to look at some of the things you might have inherited and the best way to deal with them along with recent tax law changes that could impact you as well.
Let’s get started.
Have You Inherited Some of These?
If you’re the executor of the estate, you must first determine the beneficiaries of the retirement assets. Each person’s relationship to the deceased means there are different rules on how you must distribute these types of accounts.
On a high level, if you are listed as a beneficiary of an IRA then you must open an Inherited IRA. And, unless you are the spouse of the deceased, you must distribute the entire balance of the account over a 10-year period. However, be aware that if the retirement accounts are pre-tax or Roth money there will be very different tax ramifications when you distribute the money.
If the inherited money is pre-tax, there are different strategies available to distribute the money that allows you to stay in a lower tax bracket and limit the tax ramifications.
An interesting nuance to estates is the “step up in basis” that occurs at death. When a loved one dies, the real estate or non-qualified investment account basis is “stepped up” to fair market value.
Here’s an example: If your parents bought their house 30 years ago for $250,000 and over time the house became worth $1,000,000 when they passed away, you wouldn’t have to pay capital gains on the $750,000 of growth. This is considered a “step up in basis.” The same process occurs for other non-qualified assets (i.e. non-retirement investments).
Life insurance on the life of the deceased will be passed to the beneficiaries as tax free money. Life insurance can be used to cover the debts of the deceased, replace the future earning potential that was lost from the deceased passing away, and help with burial costs, etc. In more complex situations, life insurance is used as a way to pay estate taxes or pay off business partners. The more complex and more wealth involved in an estate, typically, the more complex the life insurance structure.
Hopefully your loved one’s business had operating agreements or cross purchase plans in place with any involved partners – and if you’re reading this for the first time and wondering if they do…it should be something you look into should the unexpected happen.
Having these safeguards in place will make the inheritance of a business a lot cleaner. Illiquid assets such as a business can be complicated to get your loved one’s money out of; ideally you’d want something on file with the other partners that dictates what happens if someone dies.
Usually, these agreements are funded by the business partners getting life insurance on each other’s lives. This way if someone dies, their loved ones can get proceeds from their equity interest in the business without having a full disruption or potential sale of the business.
We’ve looked at the different assets you might inherit. In the next blog, we’ll take a look at tax implications and how to create an estate plan that could save your loved ones a lot of headaches.
Denver Private Wealth Management is an independent fee-based financial planning practice with 50+ years of experience in the financial industry. DWPM customizes portfolios based on your financial goals and works closely with you, your tax advisors and estate attorneys to form a comprehensive view of your financial situation. For more information or to set up a free consultation, contact us at firstname.lastname@example.org.
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