As older Americans prepare to transfer their wealth or will it to their family, what should inheritors know before receiving this large sum of money?
Wealthstream Advisors Financial Advisor Katharine George explains the do’s and don’ts when inheriting wealth, which includes money and even real estate property.
“I try to stay away from rules of thumbs but I would say in general, [avoid] making big decisions. I would say wait about six months or so, especially if you’re grieving,” George says. “These big changes… in that short period of time when you’re grieving if it was someone close to you, we don’t want to make any decisions that are rash. So buying another property or going on a big vacation. These big changes, it could be that you need these assets invested and saved for your long term or it could be you could retire tomorrow. It really depends on the personal situation but not making any of these big decisions immediately after is really important, really let the dust settle.”
Video Transcript
BRAD SMITH: Well, the baby Boomer generation is aging. We all are, come on now. With its oldest members nearing 80 years old. And for a generation that has done quite well for themselves, that wealth is now starting to be passed down to younger generations. Gen X and millennials are slowly starting to inherit large sums of money investments or even pieces of real estate. All of this can certainly overwhelm and alter your life.
So what should you be doing with inheritance, and what are the tax implications behind the Great Wealth Transfer as well? For more, I’m joined by Katharine George, Wealthstream Advisors financial advisor. First and foremost, we should just say, appreciate your family members while they’re here. Spend that time with them. Enjoy so much of that experience.
And then if you do have to get into a position where you’ve got to figure out what to do with this windfall of assets, now, what do you do? What is the most apt decision that people should start to make and where they can start the thought process, Katharine?
KATHARINE GEORGE: Well, Brad, I mean, there’s lots of different types of assets that people invest like you just mentioned. I’d say, the number 1 question that I get from clients who just got money is, do I have to report this on my tax return? They just got $1,000 in cash. Is this taxable? The answer is no. When you receive assets, that is not taxable. It’s when you sell something or when you pull from the retirement account, that’s really when the taxes could come into play.
But the first decision is really to decide, should I sell this? Is this an appropriate investment for me? These types of investments can be bucketed into non-retirement assets and retirement assets. And with non-retirement assets, there’s actually a big tax advantage to selling. In most cases, when someone passes away, what they paid for the asset kind of gets stepped up to the market value today, meaning that if you sell it, there’s no taxes.
So there is a period of time where you can sell the investments that you receive and maybe put it into something that would be more beneficial for you. That’s kind of the first tip.
BRAD SMITH: What about real estate or other illiquid assets?
KATHARINE GEORGE: Yes. So real estate is the number 1 illiquid asset that I see. And oftentimes, I see that someone is not inheriting that asset alone. So maybe their siblings also got a piece of it. And that can get really complicated because maybe some people want to sell it, and some people don’t want to sell it.
So that can be the first tricky thing. The second piece is, is it a rental property? Are there tenants in there? Does that cause complications? But same thing with the real estate. So if you were to sell the real estate just like the other non-retirement accounts, it gets what’s called a step up in basis. And if you sell it, there’s likely, you know, little to no tax consequences depending on the value when the person passed away, and the value when you sold the property. So that’s another advantage there.
And having liquidity. So something that’s not tied up in real estate with expenses and other things could be beneficial for the longer term.
BRAD SMITH: What is the, perhaps, best time period that people should be taking time to really consider what the options are? Is there kind of a good rule of thumb here?
KATHARINE GEORGE: So like everything else, you know, I try to stay away from rules of thumbs. But I would say, in general, making big decisions, I would say, wait about six months or so, especially if you’re grieving. These big changes in that short period of time, if you’re grieving, if it was someone close to you, we don’t want to make any decisions that are rash, right?
So buying another property or going on a big vacation. These big changes. It could be that you need these assets invested and saved for your long-term or it could be that you can retire tomorrow. It really depends on the personal situation, but not making any of these big decisions immediately after is really important. Really let the dust settle.
BRAD SMITH: I mean, there is the instance as well. If you come into an inheritance or a windfall of cash or some type of new wealth and it bumps you into a new tax bracket or it bumps you and changes your entire living status, if you will, how do people need to go about that decision making process as well and adequately adjust.
KATHARINE GEORGE: Right. So what I mentioned earlier is that there’s two buckets of inherited assets– the non-retirement and the retirement. And oftentimes, when you inherit retirement accounts, that is when you’re going to get shifted into potentially a much larger tax bracket. Because unlike the non-retirement assets, when you pull that money out, it’s taxed as ordinary income. So just like an income if you were working at a job.
The difference too is that in most cases, it’s actually really complicated, how it’s all figured out. But in most cases, you have 10 years to pull that retirement money out. So in some cases, you could bump up for 10 years your taxable income for quite some time. And the required distribution is quite low. So if you do no planning, maybe you’re not bumped into a high tax bracket for nine years, but in that 10th year everything comes out and now all of a sudden, you know, you’re in a really big tax bracket.
So I’d say, the best plan is to come up with a strategy to minimize the overall tax bill. And usually, that means taking small bits over the 10-year period so that you’re not bumped up into a big tax bracket in year 10.
