On this episode of A Wiser Retirement™ Podcast, Casey Smith, Missie Beach, CFP®, CDFA®, and Michaela Laney dive into the complex world of estate tax rates, annuities, and IRAs. We shed light on strategies like Roth conversions to minimize tax burdens and the importance of legacy planning to ensure your kids benefit from your inheritance.
The first question anyone who inherits money usually asks is: “How much tax do I have to pay?” To start off, inheritance taxes don’t apply to the beneficiary of the inheritance. However, as with most things there are exceptions to the rule. Let’s go over some of those instances.
If you are married and own an estate that’s worth over $24M, then the estate might owe taxes that will have to be paid by the inheritor. We expect the estate tax rate to go down in 2025 to around $6M, so $12M for a couple. Therefore, if someone inherits $200,000 or $500,000, that amount doesn’t present any tax concern.
Inheriting an Annuity
Annuities are the worst type of inheritance and one of the reasons for it is that they’ll always have a gain above the cost basis of the annuity. So, the inheritor will have to pay income taxes on the gains in the annuity. This is different from an IRA account.
If you are a spouse you can take over the inherited IRA into your own IRA, without any tax issues. However, a non-spouse, for example (when the IRA belonged to your parents), you have to empty that IRA over 10 years. If it’s a big IRA such as $1M, that’s $100,000 in taxes over the period of 10 years.
Inheriting Liquid Assets
After understanding tax implications, assuming you’ve inherited cash, what should you do? The first step is to steward it well. While inheriting money sounds really good, it comes with the loss of a loved one. Grieving the loss of a loved one is not a rational process, and if you add a significant amount of money to it, it may become even more chaotic. It is important to get your mental health in check to be able to separate things and not use the inherited money as escape for the feeling of emptiness. After receiving an inheritance, you can live a rich life for a year, or you can be wealthy for a life time. It’s all about how you choose to use the money that was graciously left to you.
Always Plan on Sure Facts
When clients go through our financial planning process, some mention to us that they will receive an inheritance at some point. While it’s good to be aware of it, we never incorporate future inheritances into a financial plan. You never know what can happen before a grandparent or parent’s passing.
An Inheritance as Part of a Legacy
Ultimately, you have to look at the total picture and what the most impactful thing to do with your inheritance is. Paying off a mortgage is a good example of using an inheritance wisely, because it materializes that gift from the family member. Theoretically, when focusing on legacy, you should be better off then your previous generation, and then your next generation better off than you. That is only possible with a very well thought-out financial plan, and a lifetime of discipline.
Additionally, it has become very common for people to write a love letter or a legacy letter when doing their financial planning and preparing a will. This love letter can talk about anything but it should include telling the beneficiary how you’d like them to live their life, and how this money can help them accomplish their dreams.
It’s also so important to have that letter especially if you know you’re passing down to siblings that don’t have the same financial awareness. You may consider explaining in that letter why you chose the one sibling to be the person who should manage the money. That way your legacy doesn’t end up defeating its purpose and causing resentment and division among siblings.
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