Financial Advisor Insights

Receiving an Inheritance?  What to expect

After a family member or other loved one has passed away, you may be in line to receive an inheritance. What can you expect from the legacy transfer process?

Legacy Transfer Process When Receiving an Inheritance

First, it’s important to realize that there are many legal and tax details which need to be sorted out in settling someone’s estate. For that reason, it is common for the complete process to take many months, and sometimes even years. While you may be anxious for things to be resolved quickly so that you can move on, you can avoid adding stress to an already difficult time in your life by allowing the details to be handled by a competent attorney and other professionals, and being patient with the legal process.

What is an estate?

An estate consists of everything that the decedent (the person who died) owned at the time of death – their share of the family home or homes, businesses, retirement plans, bank and brokerage accounts, and life insurance proceeds, as well as personal items such as a car; reduced by their share of any debts they had such as a mortgage. Making a complete inventory of everything the decedent owned can take quite some time – especially if they were not very organized in their record-keeping, or, as increasingly seems to be the case, only had online access to accounts and kept no record of their passwords.

Usually there will be no distributions to heirs from the estate until all of this information has been gathered, the probate process is complete, and any obligations of the estate, such as taxes, debts and funeral and legal expenses, have been paid.

What about estate tax?

At the federal level, estate tax is only owed on the amount over $5.49 million in 2017 (indexed for inflation). If the estate passes to a surviving spouse, no estate tax is due regardless of how large it is. However, a number of states have “decoupled” from the federal exemption level and charge estate tax on amounts over $1 million. So even if there is no federal estate tax due, there may be at the state level. If the decedent owned property in more than one state, that will be a complicating factor in settling the estate.

What is probate?

After a person dies, probate is the legal process that is used to transfer ownership of property from the decedent to the heirs. Assets owned in the decedent’s individual name will be subject to probate. This is a matter of public record.

In most cases, the court appoints a person called a personal representative to collect, manage and transfer estate property to the heirs. If the decedent left a will, the court determines if the will is valid.

What inherited assets do not go through probate?

This is where the importance of prior estate planning becomes clear. Some types of account registration do not pass according to the decedent’s will and therefore the inherited assets are not subject to probate.

  • Accounts which pass by beneficiary designation are considered legal contracts, and go to the beneficiaries named on the account, not via will. (Regardless of what the will says, the beneficiary designation on the account prevails.) These types of contracts include life insurance policies and retirement plans such as pensions, 401(k) plans and IRAs.
  • Assets in trusts the decedent established are also not subject to probate. Again, the terms of the Trust will prevail. A Revocable Trust, or Living Trust, which the decedent set up and funded during life will become irrevocable on death, as he or she can no longer direct changes. Usually the assets in the trust need to be transferred to a new trust account with its own taxpayer ID number, since the decedent’s Social Security number is now inactive.
  • Additional trusts may be set up as part of the estate; for example, some assets may pass to a newly-established Family Trust rather than to the surviving spouse as a method of keeping the spouse’s eventual estate under the estate tax exemption limits.

Do I owe taxes on my inheritance?

There are different types of tax that may apply to your inheritance, so the answer is: it depends.

  • Any estate tax due (as discussed above) is an obligation of the estate and is paid by the estate before you receive your inheritance.
  • If you inherited assets in a retirement plan such as an IRA, you will owe ordinary income tax on any distributions you take. So, for example, if you receive a $100,000 IRA and cash it out, the $100,000 will be added to your overall taxable income for the year, possibly pushing you into a higher tax bracket. An alternate strategy is to set up an Inherited IRA in your name; you can then take Required Minimum Distributions each year over your lifetime, stretching out the tax consequences.
  • Non-retirement assets, such as a house or a brokerage account, receive a “step-up” in cost basis to the date-of-death value. So if Mom lived in her house for 50 years, had bought it for $10,000 and it’s worth $500,000 on the day she dies, the cost basis when sold is now $500,000. If you hang onto it in your name for a few years and then sell it for $600,000, you will owe capital gains tax on the $100,000 gain between the stepped-up basis and your sale value.

By patiently working through all the steps, guided by your professional team, eventually the estate is sorted out and distributed. Then you will be ready to decide what to do with your inheritance, using it to fund a dream purchase or invest for the future. Please contact us to see how Darrow Wealth Management can advise on your next steps.

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