In today’s episode, you’ll learn more about:
- What to do first after receiving an inheritance.
- Why you shouldn’t immediately liquidate inherited assets.
- Tax considerations for inherited brokerage accounts, IRAs, Roth IRAs, annuities, and real estate.
- How inherited IRA distribution rules can create tax planning opportunities.
- Why you shouldn’t automatically keep the investments you inherit.
- How an inheritance can create an opportunity to rethink asset allocation and asset location.
- How an inheritance could change your retirement, tax, estate, and spending plans.
Listen Now:
The Smart Take:
You just received an inheritance. Now what?
Before you sell investments, take distributions, pay off debt, or make a major purchase, it’s important to understand exactly what you’ve inherited and the tax rules that come with it.
In this episode, Tyler Emrick, CFA®, CFP®, walks through the biggest financial decisions that can come with an inheritance and explains why some seemingly simple moves can create unintended tax consequences.
An inheritance isn’t a financial plan. It’s a new set of resources that needs to be thoughtfully incorporated into the financial plan you already have.
Go Inside the Episode:
0:00 – Intro
2:08 – What did you actually inherit?
4:27 – What should you do first?
5:48 – Understand the tax rules
11:28 – Rebuild your household portfolio
Learn more about the Retire Smarter Solution ™: https://www.truewealthdesign.com/ep-45-retire-smarter-solution/
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Tyler Emrick:
Receiving an inheritance can change your financial picture overnight. And often the first reaction is, what should I do with this money? But before you answer that, you need to understand exactly what you inherited. Cash, investments, IRA, Roth, real estate can all come with very different tax rules and planning opportunities. Today, we’ll walk you through what to do first, what decisions you shouldn’t rush, and how to make sure an inheritance actually improves your financial plan.
Walter Storholt:
All right. It’s another episode of Retire Smarter. Walter Storholt here alongside Tyler Emrick. He’s a chartered financial analyst and a CERTIFIED FINANCIAL PLANNER and one of the wealth advisors at True Wealth Design, based in Northeast Ohio, but serving clients all across the country. And a great topic to discuss today, receiving an inheritance and what to do. And this is important, Tyler, because-
Tyler Emrick:
It is.
Walter Storholt:
One, you’re going through an emotional time, potentially, depending on the relationship there. And two, it’s not something we’re going to go through many times in life, and a lot of people will only go through it maybe once. And you don’t have a lot of experience to draw on for going through this process. So a lot of mistakes get made during this period of time for a lot of folks.
Tyler Emrick:
Oh, absolutely. Well, because there’s a lot of decisions that are being thrown at you, right? Hey, do this paperwork. Hey, send this in. Hey, do this. And it can very much feel overwhelming. A lot of times, especially when we see our families or our clients that happen to pass away and we’re sitting down with the heirs and we’re walking them through some of the decisions, you could just see there’s a lot of emotion that’s driven in there. One, they’re grieving, dealing with the loss, and then they have some of these decisions. It’s almost like, all right, hey, let’s just collectively take a deep breath. Let’s prioritize. Nothing has to get done this second. And starting prioritizing that. But yeah. Emotions are running high and you don’t want to do something that’s wrong, but it’s a very critical time to be thinking of and walking through.
Walter Storholt:
Our last episode, we talked about the other side of the equation, like what people were thinking about before passing on money and wills and trusts and all those kinds of things. I guess today’s lens is the other side of, okay, I’m the one that has been past something and now what do I do?
Tyler Emrick:
Correct. Yeah. Which when you think about that too, when you’re going through this situation, I would urge you to … One of the big things to think about is taking an inventory of like, well, what did I actually inherit? We hit it a little bit with the lead in where we just rattled off all these types of assets that you can get. But truly, depending on what you inherit is going to drive your timeline. It’s going to drive your tax situation. It’s going to drive line what things that you need to actually do. So we want to be very, very cautious of saying, “Oh, I inherited this account. This person sent me a paperwork. I need to fill it out and I’m going to take the money and just put it in my checking account until I can breathe and figure out what to do with it.” Well, oftentimes that could get you into a little bit of a predicament.
I think back to a family I’ve been working with for a number of years. How I started working with them is they actually had a family member that had passed away. And she actually came to me and said, “Hey, I just filled out this paperwork. I got the account. I think I did something wrong.” Well, what she ended up doing was she had an annuity that her father had had. She inherited it. And the annuity company, they got the death certificate, just sent her paperwork and said, “Hey, here are your options. Oh, I’ll just take the cash and figure it out later,” without realizing that part of that annuity or a substantial part of that annuity was actually taxable if she were to pull it all out. And she’s dealing with this after the fact. In her mind, well, she was just, “Hey, checking off a box. Get this off my plate. It’s another thing that I need to do. I’ll deal with it later.” But it came up and it was definitely not a year where she wanted to take multiple six figures of additional income in that particular year.
But once she had done that, it was set. There was really nothing that she could do. And so we were picking up the pieces there. But you could understand how someone could easily make that mistake. Just trying to get through that checklist, which is essentially just what she’s doing. So we want to avoid that as much as we can.
Walter Storholt:
Makes total sense.
Tyler Emrick:
Yeah. So as you think about like, well, what should I do first? Well, I think a lot of the first things that you could do is don’t really worry about any of the accounts themselves right at the get go. Handle what’s in front of you. A lot of times you’re dealing with funerals or grief and that type of thing. Sometimes there are time sensitive issues where if you have a family member who was taking required minimum distributions from their retirement accounts or something like that, or they had passed at the end of a particular year and you needed to take care of some tax stuff, certainly some of those things can be on the docket. More commonly, it’s just, hey, making sure that social security would be notified if they’re getting … Which the funeral home a lot of times would do for you. Making sure that if there were any bill payments that were getting done. Hey, you get a handle on that and notify the proper people. So a lot of times these aren’t super time sensitive. They’re just back to that check mark, like what my client was thinking of beforehand. Hey, I just need to check off some of these things.
But make sure that moving accounts or making big decisions with moving assets aren’t part of that checklist. It’s more about the bills and taking care of some of the estate stuff that’s right immediately in front of you. Do we have the estate documents? Is there a trust? Is there a will? Who do we need to contact? That type of thing. And slow down on the big decisions before you start moving assets. But that’s-
Walter Storholt:
Because it sounds like the taxes are going to be some of the biggest question marks about what you’ve inherited. So don’t start doing things unless you’re under deadline. Don’t start doing things until you understand those tax ramifications.
Tyler Emrick:
You got it. And a lot of times these are some of the first questions that families come to me too. It’s like, well, “Hey, is that taxable to me? Am I going to have to set aside some money for that?” So it’s on a lot of families’ mind, but we just want to make sure-
Walter Storholt:
It’s a lot like winning the lottery, right? You’re going to have some decisions about how much taxes are going to be pulled from it. And do you want everything in a lump sum or do you want to hold onto it and be in the-
Tyler Emrick:
You got it.
Walter Storholt:
… overtime, all that.
Tyler Emrick:
Well, and some assets are much more tax efficient or no taxes, comparatively speaking. Let’s just run through a high level list here, just account types and some of the things that maybe individuals and families should be aware of as they think about, “Ooh, I inherited this. What’s next?” And a lot of times, some of the easiest stuff would be taxable investment accounts or checking accounts, savings accounts. What happens is at the date of death, there’s what’s called a step-up in basis, which means that, hey, if an individual has had investments for a long period of time and maybe they had grown and they didn’t want to sell them because there were big gains in taxes. Well, at their death, what happens is it’s like you purchased those investments on the date of death. So all those investment gains get wiped out and you’re able to essentially sell those investments at minimal tax sets because those basis gets the step-up. So taxable investment accounts, checking accounts, savings accounts, normally those are the ones that are a little more easy-peasy, not much tax considerations there as you’re thinking about those too.
Now, as we move into retirement accounts, this is where things get a little more juicy. So first thing is what type of retirement account is it? And when I say type, we’re really looking at, is it pre-tax or is it Roth? Because when we think about pre-tax retirement accounts, they have not paid taxes on them already. So these are things like traditional IRAs, rollover IRAs, 401ks, TSP accounts, things like that. Where when you inherit those, what happens is you want to make sure that you keep those assets in an inherited retirement account. That way you do not have a big tax bill if you were to cash it out. Because if you cash it out, put it in your checking account, if they haven’t paid taxes on it yet and it’s in one of these types of accounts, well, that is going to hit your tax return. So we want to make sure that those accounts stay in some type of inherited retirement account.
And then you will have rules that you will be subject to, Walt. The Secure Act changed a lot of these rules, which you will want to be aware of them and understand your situation. For the vast majority of individuals who aren’t spouses, we have what’s called a 10-year rule where essentially those balances would need to be distributed within 10 years and you will have a yearly required minimum. So that doesn’t mean you take the balance, divide it by 10 and that’s the equal amount each year. You have a little more flexibility in that. But if you’re inheriting a sizable retirement account that’s pre-tax, IRA, 401k, so on and so forth, the tax strategy around those distributions become pretty important.
You also want to get down into the granularity of it. What I mean by that is I made a very general assumption here saying, “Hey, you’re subject to the 10-year rule.” But there is this subset of beneficiaries here called eligible designated beneficiaries where you do have some other options. You can stretch out payments longer than 10 years. So you do want to make sure, well, hey, what are my options? What rules do I have to follow with these types of accounts before you start making decisions on moving them or distributing them? So that way you are fully aware of like, well, hey, I can get a game plan. If I got to get it out within 10 years, at least I know that and I could build a game plan around it. If I can stretch payments out over my lifetime, great. Let’s maybe do that. So understanding that I think is very important.
And it’s a little less important with Roth accounts, which are the other type of retirement accounts, but still the decision remains. Roth accounts, when you do pull them out, you don’t have a big tax bill. That Roth money has already been taxed. Well, that’s one of the benefits of Roths. That doesn’t change when you inherit them. So a lot of times you’re subject to similar rules as you would be with a pre-tax retirement account. The 10-year rule, for example. All right, I inherit this Roth, got 10 years to get it out. Well, your strategy might change a lot. Because if you can keep it in that inherited Roth, let it grow tax-free for the next 10 years. Well, hey, that’s a much different strategy in a way that you might want to take that account versus, hey, if you did that inheriting an IRA that hasn’t been taxed, well, you’ll have a huge tax bill at the end of the year … Or excuse me, at the end of 10 years because you got to distribute that money and pay taxes on it. So these account types can really change well, what do I do with it? How do I use it? How do I take distributions? Do I not? What investments do I use? All that stuff. So these retirement accounts are the ones that can get quirky and we want to be careful of them for sure.
Speaker 3:
What would your life look like if you designed it around your true wealth? It’s a powerful question and one that True Wealth Design helps individuals, families, and business owners answer every day. With a fully integrated approach to financial planning, tax strategy, investments, and business advisory, their team can bring clarity and confidence to every part of your financial life. Take the first step toward a stronger financial future with a no cost, no obligation discovery meeting. Just click the link in today’s show description to get started.
Walter Storholt:
Do you think it’s wise when you are in a situation like this to say, okay, here’s what my plan and my life looked like before this inheritance. And now I have all of this inheritance complexity to worry about. Let me treat these things separately. Keep this in this box and let me deal with the inherited stuff in its own little world. Because maybe even an emotional attachment makes you feel like you should not intermingle the two? Or do you usually recommend that families just like, all right, we’re starting fresh. Let’s look at the whole picture in a totally different way now. And is that difficult emotionally for people to do that sometimes?
Tyler Emrick:
I bet it’s extremely difficult to work through it and the decisions that are in front of you while you’re grieving. This is a very emotional time, so we don’t want to lose sight of that by any means. I think a lot of times it’s easy to look at it in a vacuum at the beginning, but we very quickly want to get it in within your entire financial picture because we pick up those efficiencies, these tax consequences, investments. All that stuff are going to be intertwined. So at the beginning, sure, to get your pick list, to get your to-do items and get it out, all right, let’s do that. But then as we start identifying the types of accounts and what we’ve got, I think it very much then becomes a much, much more broader conversation around how does this fit into your current financial picture and what you and the family’s trying to accomplish for sure.
Walter Storholt:
Yeah. I guess you could inherit things that then totally unbalance how you were previously balanced or diversified or any number of things. Tax strategy-
Tyler Emrick:
Absolutely.
Walter Storholt:
… can change all of that. You really can’t keep it in a vacuum for very long.
Tyler Emrick:
Think about real estate, right? Real estate, you inherit your family’s house. Maybe you grew up in or something like that. Do you move in there?
Walter Storholt:
Now you’re a stuck second homeowner potentially.
Tyler Emrick:
Correct. Yeah. You can absolutely throw a wrinkle in it. And speaking of real estate, that is one of those things that we want to understand. We talked about taxable investments, savings, checking accounts, retirement accounts. Real estate’s another big one that I get, especially the, do I have to pay taxes on this? So assuming that it was registered appropriately in the decedent’s name, if they pass, generally that step up and basis rule is applicable as well. So as long as you sell it within a reasonable period of time, those taxes are normally minimal or nothing because it’s like you purchased that house at the date of death. Now, there are big caveats and big issues here depending on titling and depending on how that house is titling to where maybe that step up isn’t there for you. So this all comes back to that whole webisode we did before on like, well, hey, your estate plan and how does that work? We’re looking at it from the backside, but a lot of that work and decision points to save in these taxes and things like that are done well beforehand and you’re just implementing it based off the documents that are in place with what we’re talking about today. But a lot of times that real estate isn’t as big of a tax issue if you were to go ahead and sell it.
Now, annuities, this is what that story that we talked about before, this was an annuity that she inherited. These ones are probably the most complex. Hey-
Walter Storholt:
They’re complex when you get them on the front end, let alone, I guess, this backend.
Tyler Emrick:
So this is one that takes a lot more of that well, hey, what are my options? What’s parts taxable? What part’s not? Do I have to keep it in this annuity? What are my payout options? Can I do an exchange into another annuity? Do I want to take the big tax hit? The annuity ones are, as with anything, they’re some of the most complex vehicles in our entire industry. Well, you’ve seen the books, right? I mean, thick, thick books. That same thing applies as you start thinking about how they work from an estate planning standpoint. So a lot of things to be aware of there with annuities, certainly could probably do a whole episode on annuities and estate planning around them, but just be aware of them as you start thinking about, well, is this a non-qualified annuity or a qualified annuity? That type of thing is going to drive a lot of these decision points on the annuity side. So those are high level, Walt. Those are the types of accounts and assets that we’re seeing the most. The other thing that I think comes up quite a bit here is this idea of … And I’ve run into it a lot too. Is, hey, my dad had this stock for years, never sold it. I don’t know if I want to sell it. There is that emotional attachment. Oh, these were-
Walter Storholt:
He loved Hershey chocolate and he has Hershey stock and I can’t let that go.
Tyler Emrick:
Correct. And there’s some validity there, right? I get it. Totally. And this is where, to your point before of like, well, how does this fit into the grander picture of your financial situation and what you’re trying to accomplish becomes extremely important? Are you in a scenario where you can let emotions drive it a little bit more? And hey, if you have it all in one stock and it goes down to zero, if it does nothing to your life and what you’re trying to accomplish, does it really matter or is that emotional aspect more important than, hey, maybe the more financially prudent decision of like, hey, yeah, that’s too much stock concentration or whatever. And we can see this on every aspect. I was literally just last week speaking with a prospect who I was introduced to where she was going through this situation. She was in this camp. She inherited money from her mother. And she was describing the assets. She had done a great job taking an inventory of, “Hey, this is a retirement account.” And the bulk of what she got was actually in a taxable brokerage account.
And she was aware of the step-up in basis, meaning that, hey, those investments, she could literally sell at a very low tax hit to her because she got a step-up in basis. And one of her big priorities that she was talking me through is like, “Hey, my mom had these since the ’90s. They had just grown and they were in old mutual funds that actually still had loads on them or class A, where they were a fee that was charged when you got into them. And their fees are really high. I want to get out of these things. Oh, and by the way, I got a deadline because all these old school mutual funds, she held them because, well, she had had them since the ’90s. She couldn’t sell them because she didn’t want to take the taxes so she just didn’t do anything with them.” She said this, she’s like, “If I don’t sell them by November, I’m going to get crushed with these capital gains distributions.” Because again, we know mutual funds, they have to distribute gains at the end of the year. And there’s anyone gotten the big tax bill surprise.
She’s like,” I need to avoid that. I need to get this thing rebalanced and get out of there plus they’re high costs and I can’t rebalance them where they’re at because they would charge me the big fee to get into it, the load.” So she was very educated and really understood like, hey, she had a time constraint that she had to think about and she identified it, but she did the good thing of like, well, hey, what are my assets? What did I get? And what are some of the priorities that I need to be thinking of? And she was able to identify, “Ooh, these maybe aren’t the investments that I want to hold because of some of the tax inefficiencies and the tax consequences that are going to hit me if I stay into them.” So that’s the flip side of that whole holding emotional value of like, “Hey, this is mom, dad’s investment.” To her, she’s like, “Hey, this is a big tax hit that’s coming down the pipe that I need to avoid. And how do I do it?” Right?
Walter Storholt:
Yeah.
Tyler Emrick:
So two different scenarios, but the same concept.
Walter Storholt:
Unless mom or dad or whoever have given you specific instructions like, “Son, this is really important to me that you don’t sell … I’m going to use Hershey again. “That you don’t sell this Hershey stock. I really want you to keep this.” Okay. That’s pretty clear direction and vision. And you can decide whether you want to follow those wishes or not, I guess. But don’t just make up a reason that you weren’t explicitly told of like, oh, this must have been important to dad, so I better, he would want me to. Well, they didn’t say.
Tyler Emrick:
Yeah.
Walter Storholt:
Then don’t make that up.
Tyler Emrick:
Sure. Well, do you know why they held it?
Walter Storholt:
Don’t put words in their mouth I guess.
Tyler Emrick:
It could be, Hey, I held it because I had a big tax hit of selling it and I didn’t want to sell it. It could be a, hey, I just really didn’t like that investment. I wouldn’t be in that company at all, but hey, I’ve had it for years. It’s not really impacting my financial life all that much. If something happens to it, I’m not going to take the tax hit. To your point.
Walter Storholt:
Just something made sense for them or was important to them doesn’t mean it has to be for you unless it’s been communicated in such a clear way. I think we as humans tend to make up stuff like that because we just make assumptions and we assume and we try to understand other people’s feelings and reasonings and we want to honor things in a right way, but that could lead you to making a bad decision.
Tyler Emrick:
It could, which brings us to that whole point that you alluded to a little bit earlier, Walt, is like, hey, do we bring it into our entire financial picture or bring it in? And I’m very much in the can bet eventually and as quickly as we can. There’s some value in having it maybe separated at the beginning a little bit and working through some of those decision points. But when it’s all said and done, you’re starting to hash it out and you feel like you got a good understanding of what you got well, then absolutely we want to bring it into your entire financial picture because we want to be able to pick up efficiencies. If you inherited an IRA and you got to get that thing out within 10 years and it’s a half a million bucks, well, that is certainly going to affect your taxes over the next decade. What is our game plan with that? And to understand that, we need to lump that into that financial picture. Hey, I’m getting ready to retire, but I’m going to have to take an extra X amount per year here, a tax hit. Does that affect what I’m doing for healthcare and some of the subsidies that I want to do there because I’m retiring and on an ACA plan? There’s a whole host of things that we can bring up to pick up those efficiencies.
Investments, right? We talked about what to hold, what to not. Well, depending on what type of account that you inherit, absolutely. We’ve done whole episodes on asset location and what investments, vehicles to put into different types of accounts. Absolutely we want to pick up some of that value. So bringing it into that financial picture, how does it change what you and the family are trying to accomplish? Or does it change it at all? And is it just another pot of money here that you have to accomplish the same goals that you have? I think that is a wonderful conversation as you’ve worked through some of those initial things and trying to wrap your arms around, well, how does this impact us over the long haul?
Walter Storholt:
Well, on the last episode, Tyler, we made a sports analogy. So I’ll finish this one off with a baking analogy.
Tyler Emrick:
A baking analogy. Okay.
Walter Storholt:
Yeah. Trying to reach more interests out there. Don’t always have to be in the sports world. But yeah, think about it like you’re using one of those stand mixers and you’re baking something. I don’t know, we’ll just call it a cake or whatever. You don’t just throw all the ingredients in there at once. Eventually it’s all going to be mixed in. But if you’re throwing some chocolate chips in there, you may not dump the entire bag, but you’re going to add them slowly, let it fold in. Maybe you’re trying to get the right air mixture, the right texture. And if you just do everything at once, it’s not going to come out properly. So involving this inheritance into your financial life feels a lot like baking. We’re going to withhold some of it at first. We’re going to sprinkle into things that make sense earlier, but we also need to come to the realization that eventually it’s all going into the mixer. It’s all going into the bowl and getting mixed in.
Tyler Emrick:
It’s going in the same pot. Yeah. No. You hit the nail on the head. Great analogy. And then yeah, I do need to stay away from the sports. I got called out for saying that my daughter, a couple episodes, wouldn’t be a basketball player as I was bragging a little bit because she made her first hoop on her basketball game. She’s in a basketball league and she made her first basket two weekends ago.
Walter Storholt:
Nice.
Tyler Emrick:
And I brought it up and I was like, “Oh, this was the big thing over the weekend.” And then the team immediately said, “Well, you said she wasn’t going to be a basketball player because she’d be too short.” So I got to be careful on my sports talking analogies. So hey, Kitchen-aid, talking about cookies-
Walter Storholt:
Let’s not put ceilings on our kids’ potentials here, Tyler.
Tyler Emrick:
Yes, absolutely. Absolutely. So yeah, she was pretty excited.
Walter Storholt:
I’m glad we got corrected and pushed back in the right direction on that one.
Tyler Emrick:
Yeah. It was good. It was good. But yeah, it was a fun one. Definitely important things to think about, right? And certainly emotional filled conversations. Because when you’re in the thick of it and you’re doing it, there’s a lot of things that you’re contending with so just make sure you have a good team to be able to rely on and help you through it when you’re going through something like this.
Walter Storholt:
Well, last episode we talked about, again, if you were in the other end of this equation, you’re trying to pass things onto the next generation and trying to do that appropriately. But if you’re on the other side, if you have an inheritance that you know is coming down the pike and you want to start getting ready for it and understanding your options, maybe it’s just recently happened to you, this is one of the big things that causes somebody to reach out to a financial advisor for the first time. They have an inheritance and they go, “All right, I don’t really know how to handle this, what to do, how to do that mixture. I’m not a baker, so I don’t know how to mix all these things in properly.” That’s where an advisor can really walk you through, as Tyler has illustrated today, all of those different decision points, things you need to think about as you get ready for incorporating that into your life.
And so if you’d like to talk a little bit about the moves that you can make, whether you’re a great fit to work with the True Wealth Design team, it’s easy to do so. Truewealthdesign.com is the place to go and click the let’s talk button. We’ve also got a direct link in the description of today’s show so you can find it easily and schedule that time to visit. It’s about a 20-minute meeting. Again, exploring the relationship, seeing if you’re a good fit to work with one another, and if the True Wealth Design team can help. So if you’d like to talk with an experienced advisor on the team, all you have to do is click that link or go to truewealthdesign.com and set up that time to chat. Tyler, thanks for the great breakdown today. And now I’m hungry, talked about baking. I’m going to go get some cookies or something.
Tyler Emrick:
Heck yeah. Not a bad plan. Well, we’ll catch you on the next one. It was fun.
Walter Storholt:
Sounds good. We’ll see everybody again right back here on Retire Smarter.
Speaker 4:
Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
