What to do with your inheritance: Making Your Money Work for You

Are you ready for the unprecedented $100 trillion wealth transfer? As baby boomers prepare to pass on substantial assets to Generation Z and millennials, it's crucial to approach this windfall strategically. Ohio State University conducted a study on inheritances, and the surprising finding was that over one-third of individuals who inherit wealth experience either no improvement or a decline in their overall wealth. The study revealed that, on average, adults who received inheritances saved only about half of what they inherited. The remaining portion was spent, donated, or lost in some way. So, how can you make sure you're not part of this statistic? Let's break it down.

Handling the Initial Impact

Receiving an inheritance is a blessing, but it can quickly become a curse if not managed properly. The grieving process associated with it is often underestimated because the inheritance often comes with the loss of a loved one, such as a parent or relative. It’s possible that inheritors might face unexpected emotions, such as guilt, anxiety, or a sense of responsibility. They might grapple with questions about deserving the inheritance or the pressure of managing significant assets.

One potential pitfall is making impulsive decisions during the grieving process. The emotional impact of loss can cloud judgment, leading to choices that may not align with long-term financial goals or the intentions of the deceased. Many inheritors may not have had prior experience managing substantial wealth. The lack of financial literacy or understanding of investment strategies can contribute to poor decision-making and potential financial pitfalls.

Inheritors may also face external pressures from family, friends, or society, influencing how they handle the inheritance. Balancing personal values and external expectations can be challenging and may lead to decisions that are not in line with one's true financial needs and goals. Construct a dream team of advisors, including a CPA, investment professional, and estate planning attorney. They're not decision-makers but guides, steering you toward choices aligned with your family's goals.

Understanding Your Inheritance

Understanding your inheritance can be complex and potentially confusing. Inheritances can come in various forms, including cash, real estate, stocks, bonds, businesses, and personal property. Understanding the different assets and their implications is essential for effective management. There’s a couple of issues at play that can factor into the management of your assets. 

Tax Implications:

Inherited assets often have tax implications, varying based on the type of asset, jurisdiction, and applicable tax laws. Failure to comprehend these implications can lead to unexpected tax burdens and financial setbacks.

Estate Tax: Estate tax is imposed on the total value of a deceased person's estate before distribution to heirs. However, the rules and thresholds for estate taxes vary widely among jurisdictions.

Inheritance Tax: Inheritance tax is levied on the beneficiaries rather than the estate. Not all jurisdictions impose inheritance tax, and those that do may offer exemptions or reduced rates based on the heir's relationship to the deceased.

Capital Gains Tax: Inherited assets, such as real estate or investments, may be subject to capital gains tax if sold. The tax is calculated based on the appreciation in value since the deceased's acquisition. Some jurisdictions provide a step-up in basis, potentially reducing the capital gains tax.

Income Tax on Retirement Accounts: Inherited retirement accounts, like IRAs or 401(k)s, may trigger income tax upon withdrawal. The tax implications depend on the type of account, the heir's relationship to the deceased, and whether the account is liquidated or retained.

Benefit of Step-Up in Basis: In some jurisdictions, inherited assets receive a "step-up" in basis to their fair market value at the time of the owner's death. This adjustment can reduce capital gains tax when the heir sells the asset. For example, if the deceased purchased a property for $100,000, and it's valued at $500,000 at the time of death, the heir's basis becomes $500,000.

Tax laws vary between states and countries. Be aware of both state and federal tax implications, as they may have different rules regarding estate and inheritance taxes.

Family Dynamics: 

Family structures and dynamics can complicate the inheritance process. Disputes among beneficiaries, conflicting expectations, and unclear communication can create confusion and strain relationships. It’s important to foster a space of open communication, empathy and proactive planning. Consider organizing a family meeting to address concerns, and establish a collaborative decision-making process. Involving family members in key decisions can foster a sense of ownership and reduce friction. 

Clearly outline the expectations regarding the inheritance. Documenting these expectations in legal documents, such as wills and trusts, can help prevent misunderstandings and conflicts among beneficiaries.

If conflicts arise, consider engaging professional mediation services. A neutral third party can help facilitate discussions and guide the family toward mutually agreeable solutions, reducing the likelihood of legal disputes.

Emotional Attachment: 

Sentimental value attached to inherited items can cloud judgment. Emotional attachment may lead to decisions that are not financially sound, such as holding onto assets with high maintenance costs or sentimental value but low financial return. 

Encourage beneficiaries to objectively evaluate the financial implications of each inherited asset. Consider factors such as maintenance costs, market value, and potential returns when deciding whether to retain or sell an asset. Obtain professional appraisals for valuable or sentimental items. Understanding the true value of assets can provide clarity and assist in making informed decisions that balance emotional attachment with financial considerations. Discuss how family values and memories can be preserved without necessarily holding onto specific assets that may have low financial return.

Include emotional considerations in family discussions. Acknowledge the sentimental value of certain assets and work together to find solutions that honor the emotional connection while also considering financial implications. If there are multiple sentimental items, consider implementing a rotation system among beneficiaries. This way, each family member gets the opportunity to enjoy and care for the cherished items.

Involve financial advisors or counselors who specialize in wealth psychology. They can provide guidance on managing emotional aspects of wealth and help beneficiaries make decisions that align with their overall well-being.

Unexpected Liabilities: 

Inherited assets may come with hidden liabilities, such as mortgages, loans, or maintenance costs. Failing to identify and address these obligations can result in financial strain.

Conduct a comprehensive assessment of inherited assets. This includes a detailed review of real estate, financial accounts, and personal property. Identify any outstanding debts, mortgages, or loans associated with these assets. If hidden liabilities are identified, prioritize settling outstanding debts. Work with legal and financial professionals to understand the implications and explore options for debt resolution. 

Evaluate whether it's financially viable to liquidate certain assets to cover outstanding liabilities. Selling assets may be necessary to clear debts and prevent financial strain. You can engage in negotiations with creditors to explore potential debt settlement arrangements. Creditors may be willing to negotiate terms, especially if it ensures repayment of the debt. 

Professional Guidance:

Without professional guidance, individuals may struggle to comprehend the intricate details of their inheritance fully. Consulting with financial advisors, estate planners, and legal professionals can provide clarity and ensure that all aspects are addressed.

Crafting Your Inheritance Strategy

First things first, as we mentioned assemble your dream team of professionals. That includes a CPA, investment advisor, estate planning attorney and financial planner. These professionals will provide expertise and guide you in the decision making process. 

Treat your inheritance like a pie and allocate funds strategically. Prioritize debt repayment, emergency funds, and essential financial goals.

Debt: Begin by evaluating your current debts, including mortgages, student loans, or outstanding credit card balances. Allocate a substantial portion of your inheritance to pay off high-interest debts first. This can save you money in the long run and provide financial relief.

Savings: Allocate a portion of your inheritance to establish or bolster your emergency fund. Aim to have three to six months' worth of living expenses in your emergency fund. Adjust based on your specific financial circumstances.

Setting Financial Goals: What are your goals? Homeownership? Education? A big trip to the South of France? Or maybe retirement savings. Whatever they might be, allocate a portion of your inheritance to meet these goals.

Invest: Consider diversifying a portion of your inheritance through investments. Explore opportunities like stocks, bonds, mutual funds, or real estate. Assess your risk tolerance and as always consider seeking advice from financial professionals for tailored investment strategies.

Investing Your Inheritance Wisely

Avoid putting all your funds into a single investment. Diversify across different asset classes (stocks, bonds, real estate) to reduce risk.

Stock Market Investments: Consider investing in individual stocks or diversified stock market funds. Research companies and industries for informed decisions.

Bonds and Fixed Income: Explore bonds and fixed-income securities for stable returns. Understand the risk-return profile of different bonds.

Real Estate Investments: Real estate can be a valuable investment. Evaluate rental properties, real estate investment trusts (REITs), or real estate crowdfunding platforms.

Mutual Funds and ETFs: Mutual funds and exchange-traded funds (ETFs) provide diversified exposure to various assets. Research and choose funds aligned with your investment goals.

Crafting your inheritance strategy is a proactive and ongoing process. By combining financial acumen with emotional intelligence, seeking professional guidance, and staying informed, you can navigate the complexities of wealth inheritance and turn it into a legacy that resonates through generations.

A Holistic Approach to Your Inheritance Wealth

Making the most of your inheritance requires a holistic approach. Leverage professional advice, honor your loved one's legacy, and navigate the emotional and financial terrain wisely. This isn't just about money; it's about creating a lasting impact that echoes through generations.

As the wealth transfer unfolds, ensure you're well-prepared and informed. Embrace the responsibility that comes with inheriting wealth, and let your actions contribute to positive changes in the world. If you’re still unsure on how to take the next step make sure to attend one of our financial seminars to get you started. The journey begins now, so make your inheritance count!