Understanding Your Inheritance

How Does an Inheritance Work?

For many people, receiving an inheritance can be a little overwhelming. That can be the case whether you expected it, or if it was a complete surprise. 

Whatever your situation is, it may take some time to sort through everything to understand what you have been given, what it’s worth, how it contributes to your financial wellness and what you plan to do with it. Some items may have sentimental value, like family heirlooms or things that bring back childhood memories. Others will be more financially valuable but have no sentimental value at all.

It’s important to understand your inheritance because you may need to figure out what you’ll do with some of your inheritance quickly. 

• Personal property, particularly if it has no special meaning to you, can be kept or sold without much hassle or concern for a timeline. 
• Real property, like a home or investment property, is a little more complex to deal with. Along with the property, you may have inherited some things that require attention, like upkeep responsibilities, property taxes or renters.
• Financial accounts, such as IRAs, brokerage accounts, annuities or life insurance, have special rules you need to follow. Moreover, it is important to closely observe distribution requirements to which you may be subject and be mindful of the tax consequences associated with withdrawing funds (or failing to do so).

According to the U.S. Federal Reserve, between 2016 and 2019, the average U.S. inheritance was just over $46,000 – with a large disparity between the top 1% ($719,000) and the bottom 50% (just under $10,000). If you are fortunate enough to receive a substantial inheritance, consider consulting with a financial advisor to make the most of it. The importance of doing so cannot be understated, especially when dealing with an unexpected windfall.

Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting Professional

Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

Average Inheritance Amounts

When we hear the word “inheritance,” we often think of large sums of money. However, an inheritance can come in any amount. The average inheritance in the United States is just over $46,000. This may or may not sound like a lot of money to you, but if you use it effectively, it can make a difference.

Your Tax Responsibilities

Receiving an inheritance does not automatically create a tax burden for you because there is no inheritance tax at the Federal level. 

After you receive an inheritance, you may create a tax liability by selling property or withdrawing from certain accounts, but the simple act of receiving it isn’t taxable. Some states impose an inheritance tax, so check your state law to see if you live in a state that does.

One reason you may want to speak to a financial planner when you receive an inheritance is to make sure you manage it in the most tax-efficient way possible. It’s important to talk to them before you take any action to safeguard your personal finances and make sure you don’t make the wrong move. 

For those seeking further guidance on the taxability of their inheritance, the Internal Revenue Service (IRS) provides helpful tools to assist in the determination.

How Has the Inheritance Changed Your Financial Future?

After you’ve had time to assess your inheritance and figure out what you have, it’s time to think about how it impacts you. Think about the financial goals you had before you received the inheritance and any new ones you may have now.

You may find that you are closer to achieving some of your goals or that you can now alter them to account for your new assets. You may even be able to set entirely new goals that were out of reach before.

For example, you may be able to retire a few years sooner than you were planning. Or you may realize that owning a vacation home or taking more elaborate vacations is now possible. 

Strategies for Investing Your Inheritance

Some or all of your inheritance may be eligible for investment. This could include property you intend to sell, cash or funds that are already invested. You’ll need to think carefully about how you plan to invest it going forward. When you choose an investment strategy, think back to your goals and make sure that your investment plan is aligned with them. This will help you get the most value out of your inheritance.

Your advisor can help you understand how your inheritance fits into your financial plan and make recommendations for how best to utilize it. This may involve reallocating some of the assets to diversify or complement the investments you already have.

What if You Inherit an Investment?

If you inherit investments, it’s important to think about whether those investments fit into your plan. You may want to continue holding them, or you may need to move the money into something else that works better for you. 

Those investments were chosen based on the original owner’s risk tolerance, time horizon and objectives. The likelihood that your investment matches theirs perfectly is very low. It’s best not to assume that continuing to hold the same investments is the right move.

However, you need to be careful and consider the tax consequences of any changes you plan to make. Remember that selling investments or withdrawing money may create an unnecessary tax liability for you.

Your financial advisor can explain your inherited investments to provide a clear picture of how they may help you or identify areas for improvement.