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Lisa Richmond-Kirby
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How To Make The Most Of An Inheritance

An inheritance is a wonderful financial gift.

Whether large or small, it can make a difference in your financial life, and planning ahead will maximize its impact. Here are a few ways to make the most of yours.

Know The Type of Inheritance You Have

“Inheritance” is a broad term, meaning it can take many forms, each with its own set of rules. Retirement accounts, life insurance policies, trusts, cash, and real estate are all common ways for an inheritance to transfer and come with different treatments.

Some will pass to you pretty simply, such as real estate. Once the estate is settled, the house will pass to the selected beneficiary or multiple beneficiaries. After that, you can decide how you want to proceed—move in, rent, or sell.

Other vehicles, like retirement accounts, are a little more complex and involve more rules that dictate how you must withdraw the money. The SECURE Act eliminated the “stretch” provision for most non-spouse beneficiaries. The “stretch” enables beneficiaries to spread distributions out for their entire life, but now many have to withdraw the total account balance within 10 years. Inheriting an account like this would require a good amount of cash flow and tax planning.

You may also be a beneficiary of a trust. In this case, the terms of the trust agreement will determine what amounts you will receive and the age(s) you can access them. For example, perhaps you can only withdraw funds to cover education or medical expenses. Trusts come with a stricter administrative process, which is why it’s a great benefit to entrust those duties and responsibilities to a corporate trustee.

However, no matter the type of inheritance, it’s always best to consult your financial, estate, and tax professionals. Together, you can develop a distribution plan that works best for you.

Often, people find the most benefit when they make a plan with their advisor before taking or using the inheritance.

Why?

There may be opportunities to optimize the transfer, including some dos and don’ts from the estate that can make the possess seamless for you, like reducing taxes, removing delays, and more.

Make A Plan For Potential Taxes

Inheritance and estate taxes often get confused or conflated.

Contrary to what many people believe, there isn't an inheritance tax at the Federal level, and only a handful of states have an inheritance tax.

The federal government has an estate tax, but even then, most estates are well below the exemption amount and avoid that. Currently, the lifetime exemption is $12.06 million, or $24.12 million if you’re married. Keep in mind that these sky-high numbers will sunset in 2025 if no further legislation is enacted. So it’s still important to consider the value of your estate.

Even though it’s unlikely you’ll have a specific inheritance tax, the vehicle you inherit might bring along some long-term tax consequences with it. While an inheritance itself isn't typically taxed, the actions you take after receiving the inheritance will likely have tax consequences.

For example, if you're inheriting real estate, you’ll need to consider the potential capital gains bill when you sell it. Luckily, capital gains work a little differently regarding inheritances; it’s called a step-up in basis.

Essentially, you will owe the difference between the sales price and the property’s value when you receive it, not when your loved one purchased it. This can be a massive benefit, especially for properties that have been in the family for years.

So say your dad bought his farm for $50,000 in 1940. With the wild real estate market, the new value is $500,000. If your dad left you the farm as part of your inheritance and you sold it for $600,000, you would only have to pay $100,000 in capital gains instead of $550,000.

And again, every vehicle is different.

If you inherit a traditional retirement account (401k, IRA, 403b, etc.), you have to pay taxes on the distributions. But if the account were a Roth version, you wouldn’t have to pay taxes when you take the money out (assuming your loved one followed all the rules)!

Tap the resources at your disposal to help ensure you know exactly what you’re inheriting and how you can use it in a tax-friendly way.

Use Your Inheritance To Fund A Meaningful Goal

Aside from being mindful of the taxes, you also need to think about what you’ll actually do with the money once you have it.

Like with your paycheck, any money you don’t account for tends to disappear. So what can you do with the money you inherit? Here are a few ideas.

  • Pay off debt. If you have high interest or short-term debt, like credit cards or personal loans, this is an easy win.
  • Invest for retirement. Investing in your future is always a solid use of money. You might decide to max out your 401k or IRA, but investing in retirement doesn’t have to mean funneling all your money into a retirement account. Even if you invest the money in a taxable brokerage account or a health savings account, it can still get you closer to meeting your retirement goals.
  • Invest in yourself. Maybe you want to start a business, move closer to family, or pursue more education. Your loved one gave you this money to further yourself and get you on solid financial footing. It may be a wonderful gesture to put some money into your personal and professional development. Whatever you decide, even the process of thinking about what you want will cause you to examine your priorities, values, and goals more closely.
  • Donate it. Consider giving some of your inheritance away to a cause that means a lot to you and/or the family member who left it to you. Doing so can provide you with tax breaks and allows the money to tell a story and have a purpose.

Give The Extra Money Purpose

Before you dig too deeply into exactly what you plan to do with the money, step back and think about the big picture.

Your inheritance should bolster your financial life. It’s a way to get ahead or jumpstart your effort toward reaching your goals. There are many ways to make that happen, and there’s no single correct way to do it.

As long as you are careful to use it to enliven your life and money, you’ll be further along your financial and life journey.

And remember you don’t have to do it alone. First Dakota Wealth & Trust is here to help you understand your options and use your inheritance to the fullest. Let’s get started today.

Disclaimer:

First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.

Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust, or its employees provide tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.