The Process of Inheriting Money

Because of the emotional nature of inherited money, it's worth consciously planning for its use.

This article will deal with

• the process of inheriting money,

• emotional phases of inheriting, and

• common investment vehicles for inheritance.

The process of inheriting money

When someone dies and leaves you money, your inheritance passes through the predetermined process of settling the estate.

If you are a beneficiary on a life insurance policy, annuity, retirement plan or of a trust assets pass "by contract". This means that if you are the beneficiary, this asset is yours automatically. The company who created the contract will honor your beneficiary designation after you prove who you are and upon receipt of a death certificate.

Assets which don't pass by contract go through some form of settlement process. This process is administrated by the "executor" or "administrator" of the estate of the person who died.

What is an executor?

The executor, (called the personal representative in some states) is the person named in the will to be in charge of winding up the deceased person's financial affairs. Essentially, the executor's job is to protect the deceased person's property until all the debts and taxes have been paid and to see to it that what's left is transferred to the people who are entitled to it. The law requires the highest degree of honesty, impartiality and diligence. This is called "fiduciary duty."

Executors:

• Find and total the assets and debts in the estate and manage those assets and debts during the probate period.

• Handle the details such as terminating leases, informing Social Security, etc.

• Decide whether probate court proceedings are needed and handle the process. If the estate is worth less than a certain amount (varying from state to state) formal probate may not be required.

• Figure out who inherits property by reading the will or, if there is no will, looking at the state law to see how the estate passes.

• Set up an estate bank account to pay continuing costs, pay debts, and pay taxes.

• File the final tax returns for the deceased.

• Supervise the distribution of assets.

Depending on the size of the estate and the complications of the deceased person's wishes and the types of assets, this process can be simple and fast or it can be quite complicated and take a long time.

If you are a beneficiary and the executor, set up the process by defining the tasks and being in good communication with all the other beneficiaries. Hire expertise to help you with things you don't understand. Make sure you have paid all the debts, including final medical bills, before you fully distribute the assets. You are doing a great service in honor of the person who died.

If you are a beneficiary and not the executor, have patience with this process. Understand your rights. Monitor the progress of the settling of the estate. While having patience, understand the progress of the estate settlement, and the issues involved.

Emotional phases of inheriting

If a close relative has died, you may have already been going through some emotional upset as part of the grieving process; this section will deal with common emotional reactions to receiving money.

When the check or the brokerage statements come in the mail and the money is finally yours, pay attention to how you feel, talk to your partner. Allow yourself time to feel what you feel. The rule of thumb is to avoid masking big financial decisions for six months. When you do make your choices, make sure you, the inheritor, feel good about your decisions.

• Many people first go through an initial phase where they see this money as the solution to all their problems. The amount seems so large that they can have everything they want.

• This phase often gives way to denying the existence of new wealth. They still only buy clothes only when they are on sale. They live their life exactly as if they didn't have this new money. This phase feels safe.

The only downside to this is that they give up any opportunity to have something new, like more time. Another downside is that their money is not necessarily working for them. It might simply be sitting in a savings or checking account or it might be poorly invested from the person who left it. Some people stay in this stage forever, some move on.

• Another common emotional stage is "immobilization" The person accepts that they have money, but they are immobilized because they are afraid they will make a mistake.

• Eventually, most people come around to the phase of learning about how to live with and invest their new-found wealth. This is when people begin to integrate their new wealth into their financial lifestyle and when planning is most effective.

• Finally, people get to a stage where they are able to consciously delegate authority. They are fully responsible for their new money and are able to employ expertise to manage it effectively.

Within these phases, people can have a host of powerful emotions. Often people feel guilty about their new money. Guilt paralyzes. Guilt can come in the form of knowing how the money was earned by the person who left it, (old money). Or people can feel guilty about inherited wealth because the money came with expectations about how it was to be spent. Money has the power to bring up all the unresolved issues in a relationship when a parent dies.

Closely tied to all this guilt and expectation can come suspicion of outside advice. This suspicion can produce a sense of isolation among inheritors.

We had a client who inherited money at a young age when all his friends were still struggling to make a living. He wanted to fit in, so he hid his wealth, worked in menial jobs and lived a life that most people would work hard to get out of. Needless to say, he had the money in an old brokerage account for several years before he came to see us. It had been sitting in his father's blue chip investments, untouched. When he was able to share what his brokerage statements with us, he was open to seeing that he had freedom to use some of that money to support his day to day life. Through our working together, he figured out how to integrate his wealth into his value system, change his investments to reflect his socially conscious values, and ended up going to college for a counseling degree.

Some inheritors have no idea about what they have inherited. Barbara had a client recently who came into the office with a million dollars in limited partnerships. She had no idea what a limited partnership was. She had no clue what to do, or even whether she had investments that would grow in value. On top of that, she was scared about doing the wrong thing. She inherited this money from her father, who had never discussed finances with her.

Each of these factors, and others, can lead to irrational behavior. This is one reason for the "six month rule" about making big financial choices after inheriting wealth.

Handling an inheritance within your relationship

As the inheriting member of a couple, be careful that your personal and emotional choices are honored in the big picture of your family's financial dreams.

Years ago, Barbara had a client who inherited $500,000 from her Grandpa, then shortly thereafter met and married a man who was in love with the idea of owning timber land. She invested in his dream, and the money became hopelessly tied up in a dispute about the land. They had a child and now live in relative poverty. She abdicated ownership of her inheritance "for the sake" of her relationship with her husband. She has since regretted not honoring her Grandpa's wishes for her.

This inheritance may be separate or joint property, depending on the state you live in and your legal financial arrangements with your partner. Regardless of your legal standing, this is "special money."

As the inheritor, going through these emotional stages, seek to find your personal wishes for your inheritance. Share these wishes with your partner. Discuss all the options. One of you might want to simply pay off debt and the other wants to spend the money on a big splurge. Get outside advice whenever you feel confused or hopelessly in disagreement. Think first, spend later.

Common Inheritance investments

When you receive inherited money, it may come in accounts which have specific rules. This section will deal with the most common types of inherited wealth accounts.

Brokerage Accounts

When you receive a brokerage account in your name, after the estate has been divided up, look at the statement. Look at the account and see if the investments in it fit your needs. This is your money now, so look to see if you like and understand how it is invested. Research the investments in the account. If you don't understand what you now own, get help.

Every investment that was bought by the deceased person has a basis value as of the date of death. Basis is an important concept for income tax purposes. Lets say your Dad left you stock he bought 20 years ago for $1.00 per share. It's was worth $100 per share when he died. If your Dad had sold it the day before he died, he would have owed capital gains on $99 per share. (The difference between what he bought it for and what he sold it for.) When he died, the stock's basis "stepped up" in value to $100 per share. If the stock is worth $100 the day after he dies, and you sell it, you have sold it at basis. This gives you the advantage of having more options about what you sell and what you keep because the tax burden and or benefit will be over a relatively short period of time. The step up in value also applies to real estate and other investments.

Real estate

Inheriting real estate can be wonderful or very financially and emotionally complicated. We have all heard stories of needing to sell the family house to settle the estate. You may inherit a share of a home which you, a brother or sister don't want to sell. This means that this investment is tied up in family dynamics and has some associated expenses to maintain. Even paid off homes require property tax payments and upkeep.

If you inherit investment real estate, it's much easier to do an analysis to determine whether it makes financial sense to keep it. I recommend you attempt to apply the same objectivity to family homes. If you feel that the appreciation, rental income and/or overall value of keeping it makes sense, then do so. If you are suddenly burdened with taxes and a mortgage and your entire inheritance is the house, seriously consider if you can afford the negative cash-flow. Additionally, factor in the expenses to sell the house into your decision-making process.

Inherited IRA's

If you were the beneficiary of an IRA of someone who died, you now own an Inherited IRA. The rules for an inherited IRA are different than for a regular IRA. Unless you are the spouse, you must now take a required distribution every year from that IRA, no matter how old you are. The amount of this distribution becomes taxable income on your tax return. The IRS provides a table for this mandatory distribution in their Publication590, available at www.irs.gov. For example, if you are 48, you must take 1/36 of your inherited IRA this year and that amount becomes part of your income. This gets even more complicated if your inherited IRA had after- tax contributions. Read Publication 590 and or consult a tax professional to understand what you need to do.

Annuities

Inheriting an annuity is another inheritance that might have tax implications for you. Many times, you must take an annuity within a certain amount of time and part or all of it will be taxable. Contact the company who wrote the annuity policy to find out what your situation is and what options you have. If you do have significant tax liability, try to spread your distributions over as many years as you can to minimize the possibility of throwing yourself into a higher tax bracket.

Stuff

Along with all the investments, most people inherit some art, coins, china and crystal, silver and other valuable stuff. Figuring out what to do with all this can be time consuming. If you want to sell these items, get each item individually appraised and think of selling this stuff as if you were the store owner. Make sure you feel good about what you sell it for.

Barbara Bachelder, CFP® for Wealth by Design, LLC