Your parents called, and they asked me to write you this note about what to do when inheriting their money.  I wasn’t thrilled with the idea, but they are good people, so I figured I better do it.  We both know how hard it is to say “NO” to them so let’s take a look at critical money issues surrounding inherited assets, and keep in mind, it’s written from the perspective of your parents.

Taxes

When a person passes away, they receive a ‘step-up in basis’ on all of their taxable assets.  This means their cost basis becomes the value of those assets on the day they died.  If Dad bought a cottage up North in 1968 for $5,000 and today’s it’s worth $300,000, your new cost basis is $300,000.  If Mom invested $25,000 in Apple Stock in 1994 and today it’s worth $2mm, your cost basis is now $2mm.  When you inherit taxable assets, you can sell these assets for virtually $0 capital gains.  Likewise, if you keep the asset(s), the cost basis will be the value of the asset(s) on the date of death.

IRAs

When you inherit an IRA from a parent, you have two options.

1. You can take the money directly, pay the taxes, and spend or invest as you choose. Keep in mind if you take the money as a distribution from your parent’s IRA, the entire value of the IRA will be taxable income and may push you into a higher tax bracket.
2. The best option is to move the IRA into an Inherited IRA for your own benefit. You’ll need to take out a minimum amount each year, but the balance of the account can continue growing tax deferred.  If you change your mind and want to take out most or all of the money in the future, you have that option.  Your parents worked hard to save that money for retirement and they would probably be happy if you did the same.  It’s also likely that your dad wouldn’t be happy to see 20, 30 or 40% of the money go immediately to Uncle Sam.

Financial Plan

Your parents may have been encouraging you for years to go see a financial planner to get a professional opinion on how you’re doing financially.  Begin with a plan to determine where you are in achieving your own financial goals.  If you’re behind the curve in saving for your own retirement, inherited assets can be a jump start to achieve your goals.  If your financial plan indicates that you heeded your parents advice years ago, and you’ve been saving diligently since you had your first paper route and babysitting job, then congratulations.  You’re welcome to skip the rest of the article and spend your inheritance as you choose.  To the frugal go the spoils!

Debt Paydown

There are good debts and bad debts.  Good debts are things like a mortgage that back an asset that typically appreciates and whose interest rate is relatively low and possibly deductible.  Bad debts are incurred purchasing items that depreciate in value: things like cars, boats and motorcycles.  Using an inheritance to pay for bad debts can be a good idea.  Bad debts could also be a result of bad decisions, i.e., you lived outside your means and spent more money than you should have.  Using your parents’ inheritance money to atone for a bad decision might be a good idea but recognize the value of avoiding these mistakes in the future… their words, not mine J.

College Planning

We frequently see inheritance being used to fund children’s college education or pay back student loans that your children incurred.  Those are all reasonably good things to spend an inheritance on but may show shortcomings in your own planning if you had always intended to fully pay for college.  Recognize these realities and try to adjust your spending moving forward so you’re properly saving for known and quantifiable expenses in the future.  Looking at it differently, if your mom and dad paid for some or all of your college expenses, they would have wanted you to do the same for your own kids (with your own money).

Spending Spree

It’s not uncommon for someone inheriting money to go on a spending spree.  The most common expenses incurred after an inheritance are on home remodel projects, new cars, and travel. Keep in mind that a typical home remodel project results in a 30-50% investment loss.  In other words, if you spend $50,000 to renovate the house, although your home goes up in value, you typically lose between $15,000 and $25,000 on that decision.  Purchasing a car (or cars) is also a money losing investment.  Imagine your parents knowing you bought a $50,000 car, when they spent a vast majority of their lifetime driving beaters.  They may have driven a nicer car in the last 20 years, but if you think back to the cars they had when they were your age, chances are they were much more modest.  Travel is the next most common expense.  There is nothing wrong with taking a trip, but when your previous trips averaged $5,000 and your next trip will cost $20,000 it might be worth re-routing your plans.  When in doubt, ask ‘What did mom and dad do when they were my age?’  If you look at the house they were living in, the cars they were driving, and the trips they were taking when they were your age, you would be well served to follow their example and perhaps minimize or bypass all of the above expenses.

Productive Spending

Spending inheritance money, if done thoughtfully, can be a great family decision.  If you’re looking to purchase a legacy asset that will bring the family closer together and potentially be in the family for generations to come (cabin, beach condo or ski chalet) that can be a great use of these monies and something your parents would approve of.  Perhaps you spend the money to host a family reunion or to take a trip that builds family unity, such as a cross country trip in the family station wagon with no air conditioning in the middle of a heat wave (sorry mom and dad, but how did you put an entire family in a station wagon with no A/C and think that was a good idea?).   If this inheritance allows you to spend more time with your kids or grandkids, that is something that has a lasting benefit to the family and is another great consideration.

Grandkids

Don’t forget about your parents beloved grandchildren, i.e., your children.  Your parents chose to leave you financial assets so you could have a better life.  They may hope you do the same for your children.  We are all called to leave things better than the way we found them and to make things better for the next generation.  It’s one thing to spend your own assets, but to spend your parents’ assets at the expense of your kids is nothing less than bad juju.  If you leave your children high and dry, your parents may torment you from the great beyond.

Save it and Reconsider

Frequently the best thing to do when inheriting money from a parent is the same thing your parent was doing when they passed away…saving and investing.  If you inherit $100,000 and invest it prudently you could likely double your money in 10 years.  When added to your other assets, plus your ongoing savings, that inheritance could provide the financial freedom you’ve been working towards.  After a passage of time, you’ll have greater perspective on how to handle this new-found money and you’re likely to make better decisions.

A Note to the Parents

We encourage you to have a direct conversation with your family about your money situation and the potential for inheritance.  Don’t hesitate to tell them what your intentions are for any inheritance and remind them how hard you had to work to earn it.  Tell them that you made a conscious decision to live a life driven by your values, and not consumption, and the benefits of those decisions.  Lastly, remember that you raised good kids and they DO listen.

 

Inheriting money is a big responsibility.  Parents need to speak to their children to communicate their intentions and children need to speak to their parents to learn more about how they handled money over the years.  Together you can continue building on the family legacy, which goes well beyond the money!