The death of a parent is a life changer. On top of the emotional
turmoil that comes with such a major loss, there may well be an
inheritance to deal with. Whether it's large or small, such a
windfall offers numerous opportunities for adult children, such as
paying down debt, financing a retirement or pursuing new
Two-thirds of baby boomers are likely to receive inheritances
totaling upward of $8 trillion, according to Boston College's
Center for Retirement Research. But it's easy for new heirs to make
a mess of their parents' financial legacy. The laws governing
inherited retirement plans, investment portfolios and homes are
complex. But with care, you can avoid the pitfalls.
The first step: Hold off on big money decisions. You'll need to
meet some legal deadlines, and perhaps you can visit a financial
planner to sketch out possible future scenarios. But if you act
precipitously, you can end up with an inflated tax bill or a huge
vacation home you can't afford to maintain. Don't quit your job,
start a new business, buy a summer home or dole out money to
charity, says Joan Sharp, a certified financial planner and founder
of Life Strategies, in New Castle, Del. "You need to stop and take
a breath, and don't jump into making big decisions," she says.
"People who are going through a transition are off their game,
especially when it comes to money."
You should, however, take some initial measures to protect your
newfound wealth. You may need to buy personal liability insurance
or expand the coverage you already have. Such coverage, also known
as umbrella insurance, protects you if someone is injured as a
result of your negligence--for example, if someone falls on your
property. Umbrella coverage typically exceeds the limits of auto
and homeowners insurance. "If you have a lot of assets, you become
more of a target," says Robert Pagliarini, president of Pacifica
Wealth Advisors, in Mission Viejo, Cal.
Place any cash you receive into federally insured money-market
accounts until you decide what you want to do with it. Divide the
money among several banks if you inherit more than $250,000, which
is the most that the Federal Deposit Insurance Corp. will cover for
a single account at one bank.
You could place some of the cash into a three- or six-month
certificate of deposit--the early-withdrawal penalty will help you
resist the temptation to spend immediately. "It's not easy for me
to see $1 million sitting in a cash account," Sharp says. "But
until you put a plan together, it is the wiser thing to do."
If you receive proceeds from a life insurance policy, decline an
entreaty by the insurance company or agent to sell you a new policy
or an annuity. Also, the insurer may offer to place your money in
its own money-market fund and send you a book of "drafts," which
are similar to checks. Turn down this "retained account"
option--some retailers don't accept drafts, and the money in the
account is not insured.
Also be sure to hold inherited assets in your name only.
Depending on the state, keeping the money in an account under your
own name will protect it from being divided equally in the event of
a divorce. Even if a divorce is unlikely, consider what could
happen if the assets are owned jointly and you die first. If your
spouse remarries, there is the chance the inheritance will pass on
to the new spouse or children from an earlier marriage.
It's also important to put together a team of advisers. You can
use your parent's estate-planning lawyer or use your own. Consider
hiring a fee-only certified financial planner to help you chart
some goals for your sudden wealth. For larger inheritances, seek
the help of a certified public accountant or a tax lawyer. "If a
boomer is getting a windfall, it's worth a few dollars to go to a
professional," says Martin Shenkman, an estate-planning lawyer in
The estate's executor will carry out many of the tasks of
settling the estate. Shenkman notes that a parent's lawyer
represents the executor, not the beneficiaries. "If you don't like
what the executor is doing, hire your own lawyer," he says. In most
cases, he says, the heirs and executor "are on the same page." And
typically at least one beneficiary acts as the executor.
Be careful with retirement accounts.
It's likely that a good chunk of your inheritance will be a
traditional IRA or Roth IRA. IRA inheritance rules are complex, and
you can jeopardize the tax shelter if you don't carefully follow
them. You can allow your money to grow in a tax shelter for your
lifetime, taking only required minimum distributions each year.
While a widow or widower can roll an inherited IRA into his or
her own IRA, nonspouse beneficiaries cannot. "Make sure you title
the IRA correctly," Shenkman says. "Otherwise, you can trigger
income taxes on all of it."
A nonspouse heir must set up an "inherited IRA," and the name of
the parent, or perhaps aunt or uncle, must remain on the account.
Use language like this in the title: "Inherited IRA of John Sr. for
the benefit of John Jr." If you mistakenly roll the money into your
own IRA, you will pay income tax on the entire amount.
Once you set up the new account, warn the custodian of your
parent's IRA not to liquidate the account and write you a check.
"If you take a check and cash it out, you can't put the money into
an IRA," says Diane Pearson, a certified financial planner at
Legend Financial Advisors, in Pittsburgh, Pa. "It becomes 100%
taxable." Instead, ask the custodian to conduct a
trustee-to-trustee transfer to your new account. (The 60-day
rollover rule that generally applies to IRAs does not apply to
You must take required minimum distributions from inherited
traditional IRAs and Roth IRAs. You will pay income tax on
withdrawals from a traditional IRA but not from a Roth. (You will
not owe tax on any after-tax contributions your parent made to the
traditional IRA; for the Roth, you may pay tax on the earnings in
certain circumstances.) Generally, you have until December 31 of
the year following your parent's death to take your first RMD,
which will be based on your own life expectancy. If you fail to
take a distribution by then, you must liquidate the entire account
within five years after the year of the account holder's death.
Also, if your parent died after age 70 1/2 and owned a traditional
IRA, you will need to take his or her RMD before you move the
remaining money to an inherited IRA.
If you are one of several beneficiaries of the IRA, you should
split the account into separate inherited IRAs. If you don't split
the IRA by December 31 of the year after your parent's death, your
RMD will be based on the life expectancy of the oldest
beneficiary--requiring larger distributions and depleting the
account more rapidly. By splitting the account, each heir can use
his or her own life expectancy. Be sure to name beneficiaries for
your new IRA.
Take special care if your parent named a charity as a
beneficiary along with you and other beneficiaries. You must split
off the charity's portion by September 30 of the year following the
account owner's death. If you don't, the account must be emptied
within five years after the owner's death. (For more information on
inherited IRAs, read IRS Publication 590, Individual Retirement
Arrangements (IRAs), at
If you inherit a 401(k), the distribution rules typically are
similar to those for IRAs. However, some plans are more
restrictive. For example, a plan could require that the assets be
withdrawn within five years after the account holder's death rather
than over the beneficiary's life expectancy. The simplest option is
to roll the money into an inherited IRA.
Determine the future of the family home.
Your first concern should be securing and maintaining the house
until you, and other heirs such as siblings, decide what to do with
it. If no one is living in the house for a period of time, consider
installing an alarm system if there isn't one already. Check in
periodically to make sure nothing is amiss.
The beneficiaries--or the executor of the estate--will need to
make sure that utility, tax and any mortgage bills are paid. Until
the estate has cleared probate, the bills will be paid from the
estate. Pearson suggests calling the homeowners insurance company
to check on the insurer's requirements after the death of a
homeowner. "Some companies don't want a house sitting empty for six
months or more," Pearson says.
If there's still a mortgage, advise the lender of the owner's
death. The beneficiaries, or the executor, must keep the payments
up to date to avoid foreclosure.
You and your siblings may have an emotional attachment to the
house, but if none of you wants to live in it, you'll need to
decide whether to sell it or rent it out. "In a lot of markets, you
are better off selling rather than renting, especially if you
include the cost of property taxes and insurance into your
calculations," Pagliarini says. The benefits of selling could grow
if the house still carries a mortgage or a home equity line of
credit, or requires substantial repairs--the rent you can charge
may not cover all of the costs.
The value of the house is included in the estate for purposes of
determining whether any estate tax is due. However, heirs get a
break on capital-gains taxes. When you inherit a house, the value
on which gain or loss is based is the fair market value of the
property on the date of death of the previous owner (or in some
cases, six months after that date). This "stepped-up basis" rule
means you won't owe tax on all the appreciation during the period
your parents owned the house.
Suppose you inherit a house that your parents bought 30 years
ago for $50,000. When your last surviving parent dies, the house is
worth $400,000. You will not owe capital-gains tax if you sell the
property quickly. If you hold on to the property and sell it for
$475,000 in a few years, you will owe capital-gains tax on
If one sibling wants to live in the home, the division of the
assets should include the value of the house. Say there are four
siblings inheriting a total of $4 million, including a house valued
at $1.5 million. If one heir wants to keep the house, he or she
would have to pay the other heirs about $166,000 each if the heirs
want to keep the split even.
Reevaluate your investment strategy.
Perhaps your parents held significant amounts of cash or tax-exempt
municipal bonds, while your target allocations include a larger
share of stocks. "You want to make sure the new assets are
coordinated with your existing investment strategy," Pagliarini
One break: As with the house, heirs get a step-up in basis for
inherited stocks, bonds and mutual funds. If you want to diversify
the assets by selling securities in a taxable account, you won't
pay capital-gains tax unless the securities have increased in value
between the day of the parent's death and the date of the sale. (If
a security loses value, you can use the loss to offset any capital
gains in your portfolio.) You won't owe tax if you reallocate
holdings in an inherited IRA, either.
Often, a parent's stock holdings are as laden with emotion as
the family china. Adult children may remember their parents
discussing their favorite stocks at family dinners, for example.
"It can be difficult to part with the stocks because they hold
sentimental value," says Jack Riashi Jr., a certified financial
planner for Bloom Asset Management, in Farmington Hills, Mich.
Riashi recalls one client who inherited a portfolio that was 35%
invested in ExxonMobil stock. Although the stock paid a nice
dividend, it took time for Riashi to persuade his client that
diversifying the portfolio was safer in the long run. They scaled
back the ExxonMobil stock over a couple of years, to about 4% of
If an investment portfolio must be divided among two or more
heirs, Riashi says it's best to transfer equal amounts of shares of
each fund or stock to each beneficiary's account. And make sure the
pro-rata division takes place separately for the taxable account,
traditional IRA and Roth IRA, he says. A sibling who gets $500,000
in a traditional IRA, and must pay income tax on any withdrawal,
would fare worse than the sibling who gets the $500,000 in a
Before you spend too much time reallocating investments, you and
a financial planner should discuss possible uses for the money.
Perhaps you want to use some of it to start your own business,
retire earlier than planned or pay for a grandchild's college
education. Inherited assets could open the door to an extra tax
break if they allow you to divert more of your salary to a company
401(k) or a deductible IRA.
Check for any tax bite.
Most assets you inherit come to you income-tax-free, including life
insurance proceeds and the value of stocks, bonds and real estate.
A major exception: Withdrawals from an inherited traditional IRA or
annuity will be taxed to you exactly as they would have been taxed
to the original owner.
You'll owe federal estate tax only if the estate is larger than
$5.34 million in 2014 (up to twice that if the first parent to die
preserved any unused estate-tax exemption). But if you live in a
state with its own estate or inheritance levy, the estate or heir
may owe state tax.
You also could owe income tax for any income that was owed to
your parent at the time he or she died. This includes any salary or
unpaid interest or dividends. If the estate owes federal estate
tax, you may be able to take a tax deduction for what is known as
"income in respect of a decedent."