The 2018 Survey of Consumer Finances (SCF) found that the median inheritance in the U.S. is $69,000. Yet an HSBC survey found that Americans in retirement expect to leave nearly $177,000 to their heirs. As it turns out, the passing of property and assets doesn’t always go as expected or planned. Plus, though it may seem like a windfall, getting an inheritance is rarely as easy as depositing a check. Read on to learn exactly how inheritance works.
How Inheritance Works When There’s a Will
When someone dies and there is no living spouse, survivors receive the estate through inheritance. This is usually a cash endowment given to children or grandchildren, but an inheritance may also include assets like stocks and real estate. Asset distribution is determined during the estate planning process, when wills are written and heirs or beneficiaries are designated.
The will specifies who will receive what. To distribute everything evenly, one can simply list beneficiaries. If certain items are to be left to certain people, that must be spelled out in the will. For the inheritance process to begin, a will must be submitted to probate. The probate court reviews the will, authorizes an executor and legally transfers assets to beneficiaries as outlined. Before the transfer, the executor will settle any of the deceased’s remaining debts.
How Inheritance Works When There Isn’t a Will
Inheritance becomes more complicated if the deceased did not outline asset distribution before death. In that case, a probate court must determine the wishes of the deceased as best it can. The probate court will check to see if the deceased named beneficiaries on stocks, bank accounts, brokerage accounts and retirement plans. Real estate, jewelry, heirlooms and other property can be more difficult to allocate.
Once the plan is established, the court will appoint an administrator to act as executor and disseminate the assets. This process can take months or years to settle.
When an Inheritance Has Restrictions
If you are on the receiving end of an inheritance, be sure to read the fine print. The will writer can specify that the amount is paid in small installments rather than in one large sum. He or she can also restrict the inheritance to certain uses, like education. Depending on the terms of the will, you may only receive the money when you reach a certain age or a milestone, like college graduation or marriage.
Are Heirs Responsible for the Debts of the Estate?
Though creditors may attempt to collect debts from the deceased’s family members, they are not directly responsible for them. The executor of the will or the administrator pays any estate debts before distributing what remains of the estate. So as an heir, you aren’t personally responsible for those debts and you should point creditors toward the estate.
Where There Are Inheritance Taxes
While there is no federal inheritance tax, six states impose inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In all of these states, a spouse is exempt from paying inheritance tax. Children and grandchildren are exempt from inheritance tax in each of the states except for Pennsylvania and Nebraska. Exemptions vary by state for siblings, aunts, uncles and sons-in-law and daughters-in-law. You will likely face higher inheritance tax rates if you aren’t related to the deceased.
Where there is an inheritance tax, the tax rate depends on such factors as the state, your relationship to the deceased and the amount you inherited. Rates range from 0% up to 18% of the value of the inheritance.
Inheritance tax is often discussed in relation to estate tax. These are two distinct taxes. The beneficiary pays inheritance tax, while estate tax is collected from the deceased’s estate. Assets may be subject to both estate and inheritance taxes, neither of the taxes or just one of them. Maryland and New Jersey are the only states that collect both estate and inheritance tax. In those states, inheritance can be taxed both before and after it’s distributed. Of course, state laws change regularly. It’s always important to double check with your state tax agency and maybe even an estate lawyer.
Inherited lump sums aren’t considered income. However, you could pay taxes on assets that create income. If you inherit stocks, real estate or other items that appreciate, you may have to pay capital gains tax once you sell them. The amount you’ll pay in capital gains tax is based largely on the amount of profit you make, using the value at the time of inheritance as your cost basis. If you inherit a retirement account, you’ll have to pay income taxes on distributions. Inherited Roth IRAs, however, are tax free, as are life insurance proceeds.
The Bottom Line
Coming into a large inheritance doesn’t guarantee financial security. Without a plan, it’s very easy to blow a windfall. The sudden rush of money is known to spark lifestyle inflation and irrational behavior. Beneficiaries are sometimes in worse financial shape after inheritance than before. If you’re set to inherit a sizable chunk of change, be realistic about the amount you’re inheriting, assess your current financial situation, consider your goals, establish boundaries and spend thoughtfully. Debt repayment and investing should be top priorities.
Tips for Managing an Inheritance
- Don’t go it alone. Getting an inheritance is a great time to find a financial advisor. You may be unsure of how best to use your newfound wealth, and you’ll likely have questions. An advisor can help you draft a financial plan with your windfall factored in and decide how to invest your money so it grows over the long term. A matching tool like SmartAsset’s makes it easier to find an advisor who meets your needs. Once you answer a series of questions about your financial situation and needs, our tool will match you with up to three advisors in your area.
- Think before spending. Too often, people squander sudden wealth. Consider putting your money into a savings account to give yourself time to grieve your loss, and then start assessing your financial situation with a clearer frame of mind.
- Realistically assess your inheritance and prioritize your goals. Are you behind on saving for retirement? Are there high-interest debts you have yet to pay off? Have you been meaning to start saving for your child’s education? Many advisors recommending using inheritance to first create a rainy day fund, then pay down debts and then to fund retirement savings.
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