Q: I just found out that I will be inheriting some substantial money from my father’s estate. I’m fairly young, earn a good income, have some credit-card debt and a mortgage. I guess I’m not sure what I should/should not do with the inheritance. Can you help?
A: From my experience helping people manage an inheritance, the best first step is often to take a deep breath and do nothing right away. There’s typically no need to rush into making any quick decisions; better to let your windfall sit for a bit, which will afford you time to create a thoughtful strategy.
Whether you are the recipient of an inheritance, a windfall or a bonus, new wealth brings with it new issues. This checklist can help you identify common tax issues, as well as formulate plans for investing and gifting your newfound wealth.
Here’s a list of the different types of taxes that you may encounter as a recipient of sudden, substantial wealth. As you go through it, keep in mind that different states have different rules.
Federal, state and local income taxes
While inheritances may not normally be counted as income, payments like buyouts, fees and winnings may be. Even though you may not need to formally pay any taxes due until you file, the IRS and many other jurisdictions require estimated tax payments if your tax liability for the year won’t be covered by your tax withholdings.
Real-estate transfers often include a tax, and that tax is often paid by the buyer (or the recipient). Transfer taxes may also be assessed if you receive investment securities and valuable personal property such as fine art, jewelry or antiques.
State inheritance taxes
The IRS and some states collect any estate tax due from the estate itself, before assets are distributed to beneficiaries. However, some states require beneficiaries to account for their share of a taxable estate and to settle their state-tax liabilities individually.
Ad valorem taxes
These taxes are assessed periodically on the value of an item in your possession rather than on a cash flow to you. For instance, some jurisdictions consider investment securities to be taxable personal property and levy taxes on them in the same way they do on real estate, automobiles and jewelry.
You should consider talking through these tax issues with a tax professional. You may even find that it helps to create a fund now to meet anticipated future tax liabilities.
Put new wealth to good use
New money may open up new possibilities. Think about how any new priorities might fit with your current plans and goals. For instance:
An influx of money may free up your current cash flow, allowing you to increase your contributions to your employer-sponsored retirement-savings program and/or to evaluate opportunities for an IRA. You also may find that an annuity might be beneficial.
Make sure you’re financially prepared for your children’s future education needs. Consider making full use of 529 plans, Coverdell educational-savings accounts and other education-savings vehicles for all your children and/or grandchildren.
Weigh the potential return you could earn from new wealth against the cost of carrying your current debt load. You may find it’s time to speed up some debt repayments. Prime candidates may include credit cards and other consumer debt, student loans and home-equity lines of credit.
Plan ahead to create your legacy
Consider how you can use your estate plan to extend the reach of your wealth. For instance:
• Could your new wealth help you to increase the amounts of your bequests to the people in your life you care about?
• Is it important for you to leave a legacy through good works? You may be able to do even more good by increasing your charitable efforts.
• Any trusts you might have created were probably built to make the most of the resources that you had at the time. You may find that your new wealth has changed your circumstances enough to justify rethinking your existing arrangements.
Last, but not least, did your new wealth come with any strings attached? If so, you may want to take the time to understand those special terms or conditions now. For instance, there could be limits or restrictions on how you can use the money or the items you inherited. You may be required to do something or avoid doing something in order to qualify. In addition, some bequests may depend on specific market events or other outside conditions.
For help with special conditions or any other aspect of managing newfound wealth, contact your financial advisor or other trusted planning specialist.
Jeremy R. Gussick is a Certified Financial Planner™ professional with LPL Financial, the nation’s largest independent broker-dealer.* Jeremy specializes in the financial-planning needs of the LGBT community and was recently named a 2014 FIVE STAR Wealth Manager as mentioned in Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, including the Delaware Valley Legacy Fund and the Independence Business Alliance,, the Philadelphia region’s LGBT chamber of commerce. OutMoney appears monthly. If you have a question for Jeremy, email [email protected] LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
This article was prepared with the assistance of Wealth Management Systems Inc. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Please consult me if you have any questions.
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*As reported by Financial Planning magazine, 1996-2015, based on total revenues.
**Award based on 10 objective criteria associated with providing quality services to clients such as credentials, experience, and assets under management among other factors. Wealth managers do not pay a fee to be considered or placed on the final list of Five Star Wealth Managers.