When it comes to getting a big lump sum of money, the often-used phrase is “don’t spend it all in one place.” More importantly, if you want that money to last a life time, you must have it invested well. Inheriting money can be the most impactful financial event that someone experiences. Having a plan on how to invest, disburse, and use the money is extremely important. My goal is to give you, the reader, practical and accurate information in case you end up inheriting a large sum of money.
There are a few initial questions and important pieces of information to find out if you inherit money:
- First, what type of money are your inheriting?
- Is the inheritance coming from a retirement account like an IRA or Roth IRA?
- Are they stocks in a taxable account?
Taxable Accounts Invested in Stocks
As of October 2022, the current tax law allows for a step up in cost basis on stocks in a taxable account at a persons death. For example, let’s say you inherit money from a family member that is invested in stocks and they originally bought the stock for $10. Now it is worth $100 your cost basis, meaning the price you’d owe taxes on gains would now bump up to $100/share.
Compare this to the deceased family member selling before they died. They would have owed capital gains tax on the $90 gain (100 minus 10). For most people, this is a 15% tax rate. As someone receiving the step up in cost basis, this is a HUGE benefit because you don’t pay tax on that $90 gain. This is a reason why, for older investors, holding on to stocks in taxable accounts can sometimes make sense. That is, if they have a very low-cost basis like in the example above.
Once the money is received, if it makes up a large part of the inheritance, it may be best to sell it to help diversify the investment portfolio and spread out the risk. Concentrated stock positions are very common as people age because investors get nostalgic about their winners and want to keep holding that position almost as a badge of honor. There’s nothing wrong with keeping a winner. However, when it makes your portfolio un-diversified, that can lead to big potential losses if that stock moves down. Diversification is an investor’s best friend.
Inheriting Money from a Retirement Account
Retirement account inheritances are very different from inheriting taxable investment accounts. As a result from the SECURE Act passed in 2019 and effective in 2020, retirement accounts inherited by non-spouse beneficiaries have to be withdrawn within 10 years. This forces investors to pay taxes on pre-tax accounts like a traditional IRA. Roth IRA money has to be withdrawn within 10 years, but there are no taxes paid on withdrawals since Roth IRAs are after tax contributions.
Set Goals
Once you find out the type of money you’re inheriting, this is when you should put some serious thought into what your goals for the use of this money are going to be.
Common examples:
- Supplement Current Income
- Keep It Invested to grow towards retirement, but change the portfolio to be based on your financial needs and goals in the future.
- Make plans to have the Money Passed Down to the next generation
- Often times the sandwich generation are the ones inheriting the money from parents that pass away. However, they don’t need or want the money. As a result, they want to pass it to their kids (the deceased grandkids).
- Pay Off Debt
- Make sure that, if you plan to pay off debt, this is higher interest rate debt, not a mortgage with a 3% interest rate. If invested well, the money should make a much higher rate of return than 3-4% over a longer period of time like a 20- or 30-year mortgage.
- Charitable Gifting/Planning
Once you figure out what your goals are for the money, which may be the conversation you want to have with a CFP® pro that can help talk you through a plan, the next step is implementing the plan.
Investing the Inheritance
This is the step where you want to implement an investment strategy based on how you plan to use the money. It may be geared towards current income, if you’re a spouse that inherited money. On the other hand, your strategy may be to aggressively grow the money over a 10+ year timeframe because you have no use for the money right now.
If the inheritance is in retirement accounts, you’re going to be forced to take some or all of that money out over that 10 year period. So, if you have no plan to spend the money, it will just get reinvested in your own retirement account and/or taxable accounts. If this terminology is a bit high level for you, it’s worth the time to either do the research to educate yourself or meet with a CERTIFIED FINANCIAL PLANNER™. A CFP® can help guide you through the decision making process, implement a strategy, and monitor the investment strategy.
Overview on Inheriting Money
When it comes to inheriting money, here are my last few nuggets of advice:
- Take the time to make the right plan.
This was someone’s life savings. It’s important to be a good steward of that money and make the right decisions that maximize the positive affects of being the benefactor of the money. - Don’t make emotional decisions.
When it comes to money, let the dust settle before making any major purchases or withdrawals because these emotional decisions often times can’t be undone.
If you have questions, don’t hesitate to reach out to me personally. Thanks for taking the time to read this!