Over the next 20 years, more than $84 trillion will change hands in some form of inheritance. Unfortunately, an estimated 70% of inherited wealth will be gone by the second generation, and 90% by the third generation. How is this possible?
The reality is that many beneficiaries might not feel equipped with the knowledge or tools to manage an inheritance when they receive it, and that gap leads to costly decisions.
This blog covers a few basic steps that you can take with your children that can help prepare them for receiving an inheritance.
Key takeaways:
The first step to help prepare a child to receive an inheritance is being transparent with what is being inherited. When the time comes, there shouldn’t be any surprises.
Have an open conversation discussing every type of asset they are expected to receive, including:
Be as detailed as possible and include the estimated value and/or location of those assets.
It’s just as important to discuss what their inheritance isn’t. When receiving a windfall, it’s easy to think of your immediate wants or needs. It’s tempting to buy a new car, or take a dream vacation, but having a wait-and-save strategy for an inheritance will have a much larger impact long-term.
After understanding what they’ll be receiving, the next step is discussing what they can actually do with an inheritance.
Rather than viewing an inheritance as ‘free money’ to spend right away, encourage them to think about what actions they can take that will benefit their financial situation in the long term. This could include:
The liquidity of assets also plays a large part in your options. For example, a cash inheritance may be available immediately without tax consequences, while inherited retirement accounts (401(k), IRA, brokerage accounts) often have distribution requirements and tax consequences.
One of the biggest rules when it comes to inherited IRAs is what is known as the 10-Year Rule, which is that non-spousal heirs must empty the inherited account within 10 years. During that time, withdrawals from traditional accounts are taxable as income.
The optimal strategy for navigating the 10-year rule will largely depend on the beneficiary’s own income and tax bracket, their timeline towards retirement, and of course, the total value of the IRA. For some, dividing the withdrawals evenly over 10 years may make sense. For others it could be only withdrawing the minimum distribution for 9 years and drawing the remaining balance at year 10. To learn more on this, read our blog on Inherited IRA Withdrawal Rules: What Heirs Should Know Now.
Additionally, inheritance in the form of stocks, bonds, mutual funds, real estate, or some physical assets receive what is called a step-up in basis, which is a tax provision that resets the cost basis of an inherited asset to its fair market value on the date of the original owner’s death. In other words, this eliminates the capital gains tax on any growth that occurred during the deceased person’s lifetime.
Preparing your children for an inheritance isn’t about making concrete plans today. It’s about giving them the tools and knowledge to feel confident to make decisions when the time comes.
Whether your children inherit cash, investment accounts, real estate, or other assets, working with a trusted financial adviser can help them understand the tax implications and create a long-term strategy that aligns with their existing financial plan and goals.
To learn more about the different options all beneficiaries have when receiving an inheritance, watch our webinar ‘Maximize Your Inheritance: Smart Strategies for a Lasting Impact’.
If you or a family member is interested in learning more about inheritance strategies, or anything else regarding your financial planning, click here to get in touch with one of our advisers.