By: Paul Morrone
Very few people are willing to turn down a financial windfall, nor should they. The most common way this happens is through inheritance, and as the boomers continue to age, millennials are the ultimate beneficiaries of the hard-earned wealth their parents have created. We’re fortunate to work with families on both ends of the spectrum, and those who are proactive run into less surprises when the time finally comes for wealth to pass to the next generation.
For the next generation beneficiaries, it is important to establish your baseline before anything hits your bank account. This means taking a deep look at your lifestyle, organizing priorities and discussing goals (with your spouse as well). You should understand what is coming your way, what you want it to enable you to do, and how you can most efficiently manage the transition of that wealth so that you can be a good steward of it for the rest of your life.
Of course, you have to inherit the money first. Taxes, expenses, liquidity, risk and liability are only some of the factors that need to be addressed as you assess what you are inheriting. And what many don’t realize is that not all money is created equal. Let’s look at a few examples:
- Cash is cash and with a $1.0mm bank account, what you see is what you get.
- Inheriting $1.0mm of securities is rather straightforward, however, securities change in price every day. This means that if there are material (upward or downward) market movements between the passing of an individual and when the beneficiary inherits the funds, there could be a significant difference between what they get relative to their original expectations. Income taxes can also come into play here as well.
- A house valued at $1.0mm at death is really only worth what a buyer is willing to pay for it. Maybe that’s more than $1.0mm, or less, depending upon the market for that home at the time it is finally sold. There are also carrying costs to maintain the home prior to it being sold, which can be substantial depending upon how long an heir takes to liquidate the property. Then there are closing costs which would be anywhere from 5%-10% of the sales price, further reducing the net value of the home. And all of this assumes there isn’t a mortgage on the property, which comes right off the top!
- A $1.0mm IRA can be worth anywhere between $600k and $800k, based upon your marginal tax rates and how you cash it out. In most cases, non-spouse (i.e. child) beneficiaries of IRAs will also be surprised to find out that they have a narrow 10-year window in which to plan for these distributions before the account must be closed to comply with current tax law. For many millennial heirs, they will likely receive these accounts during some of their peak earning years, meaning tax erosion can have a huge impact on how much they can ultimately spend from these accounts.
- Annuities come in various forms and may pass assts in the form of an IRA, as a monthly payment or as an inherited annuity subject to annual required distributions. There are always tax implications to these as well, which will likely have an impact not just in year 1, but for many years after the property transfers.
- A ROTH IRA, on the other hand, is generally tax free to a beneficiary so they will get to benefit from the full value of the account without the substantial cost of taxation. There are tax nuances here as well, but this is generally a favorable asset to inherit.
While this is only a small sample of the types of assets that can pass from one person to another, these are by far the most common. You can see that each one requires careful consideration and coordination as they are integrated into your personal financial plans. Having a team of competent financial planners, accountants and attorneys that work together is key to achieving your desired outcomes, as they will help shape, maintain and execute your plans over time.
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