Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

For millions of fortunate Americans, receiving an inheritance can be more satisfying (and certainly more likely) than winning the lottery. Over the next 50 years, $41 trillion to $136 trillion will be passed between generations, according to The Journal of Gift Planning. That means about $1 trillion to $3 trillion is inherited every year in the U.S. Although those numbers in aggregate are impossible for most people to wrap their heads around, there are ways you can prudently plan for your own inheritance.

Yet planning for an inheritance can be thorny. You can be consumed by unrealistic ideas and make a number of missteps that could reduce the value of what you receive over time. Taking a few preparatory steps can help ensure that the money will last to meet your major financial needs.

1. What kind of assets will you receive?
Is it real estate? Stocks and bonds? All or part of a business? An individual retirement account? What is the value of the inherited assets? These are essential questions, because you will need to do some tax planning to ensure you do not get socked with outsized capital gains or estate taxes. At the very least, you should have a good idea of the kinds of assets that you will inherit, so you can have a productive discussion with a financial professional about whether you will owe any taxes when you receive them. In most cases, that is not an issue, but it gets complicated when you consider the transfer of closely held stock, stakes in a business, and real estate. If you are receiving collectibles such as artwork or jewelry, you may need to value the items and obtain additional insurance.

2. How will the assets be distributed?
Again, this may trigger some taxes and other considerations, so you need to plan ahead. Many inheritances—particularly those for younger people—may be placed in trusts and distributed over time. Then, after college, the children would be granted gradual access to the rest of the money in the trust. In cases where money is bequeathed to minors, several safeguards will likely be in place to ensure that they do not go through their inheritance too quickly.

3. Have you done your own financial planning first?
Receiving money is great, but have you established your own estate and retirement plan? It is important to work on your own retirement planning and ensure that your spending (relative to your income) is sustainable. Further, you should not fail to have a financial and estate plan and delay important decisions because of an impending inheritance. Some essential planning questions to consider: What happens if you receive an inheritance and die suddenly thereafter? Are your own affairs in order? Are there charitable intentions that you did not think you had now possible to fulfill? Should a trust be considered? Do you still trust who would be handling the larger estate?

4. When you get the money, what are your priorities?
This question is easily answered if you have a plan in place prior to receiving the inheritance. Do you need to pay off some debt? Are you still in college-saving mode for children? Is your retirement adequately financed? Working with a financial professional will help you crunch some numbers to see what the best immediate use of the money is before you actually receive it. Are there competing demands on how to spend the money (paying off debt)? If so, you need to determine where you can get the biggest bang for your buck for the long term. What does it mean long term to pay off debt vs. investing? Existing loan interest rates need to be analyzed in conjunction with assumed rates of return. Other options—if your family financial obligations are satisfied—include setting up a family foundation or targeting specific charities or civic organizations.

5. What are your other obligations?
There may be an emotional link to the money you receive. You may feel that “dad wanted me to spend money on the business” or some other expressed or unexpressed intentions. Another relative may have received less money in the inheritance, but have a greater financial need than you do. Once you work through the priorities in your financial plan, you can consider helping family, charities, and your community. You will also need an estate plan yourself to ensure that, if you or your spouse die, the inheritance passes to the right people and does not get consumed in court battles or by taxes.

6. Is the inheritance transparent?
Consider holding a family meeting to see exactly what is involved in the process. A “drafting memorandum” can be prepared by an estate-planning attorney or financial planner to detail the assets coming from the inheritance for each family member. It is often not useful to wait until the person gifting the money dies to find out the amount being bequeathed. Financial professionals will need to know how assets are titled and valued, and potential tax implications. You will probably need to work with an estate-planning attorney.

 

©Morningstar 2016. All Rights Reserved. Used with permission.