So you have inherited money? Now what? Let’s explore the technical aspects of an inheritance.
Even If You Inherited Money You Might Need Advice
Now before we begin I should explain where this topic is coming from. There is a lot of ire in the personal finance community directed at folks that inherit money rather then earn it. I don’t subscribe to this theory given how many people I have seen blow windfalls away quickly. No matter your story you probably will benefit from financial knowledge.
Power of Attorney (POA) and Inherited Money, Oh How Complex
But if you are one of these people you can rest assured I am not nor have I inherited any sizable amount of funds. Unfortunately I am learning all about this topic through the lens of a power of attorney for someone else. Still, I hope for our audience that any benefits derived from this piece are born by you personally.
Anyway with the hopefully unnecessary qualification out of the way, let’s begin. Let’s start with beneficiary accounts.
What is a Beneficiary?
Most investment accounts, including high yield savings accounts and brokerage accounts have what is called a beneficiary. A beneficiary defines whom the assets will pass to in the case of your death. These beneficiaries actually take precedence over a will. Such assets are usually the first to pass to heirs since often times you can do a direct transfer from one the ancestor’s accounts to your own after a death certificate is provided.
There are some things to be aware of for beneficiary inheritance. The first is depending on the state and the type of account inheritance tax might still be due. Federal inheritance tax doesn’t come into play until amounts of approximately 11.5 million dollars. But state inheritance tax limits may be much lower.
Who Pays Inheritance Tax for Beneficiary Accounts
Who pays this inheritance tax also comes into play. When you die your will, or the state if you have no will, appoints an executor. Your executor is in charge of paying any outstanding debts, providing documentation, settling most tax bills, handle final rites, and finding heirs. In most states they would insure any estate tax is paid out of the dead individual’s accounts before they are dispersed.
But not all “inheritance” taxes are estate taxes. An estate tax is paid for out of the funds of the estate before it is dispersed as you see above. But an inheritance tax might be paid out of the funds of the person inheriting, depending on the state. In my POA’s case the estate paid the taxes, but something to watch out for.
I should pause here. Being an executor for an estate is fairly complicated. I am not, nor have I ever been an executor. This piece will not talk about being an executor.
Processing Beneficiary Inherited Accounts
Anyway, for those beneficiary accounts the executor provides the death certificate. Then you the inheritor will likely fill out some forms on how you would like to receive the funds. For most beneficiary accounts you will have an option to have the money dispersed to you, or have it rolled to another account.
Here is where it gets tricky. What type of account did the deceased have? For a savings account or taxable brokerage whether you roll the account Into another similar account or disperse it is not a big issue. But for Tax advantaged accounts you need to be careful.
Dealing with an Inherited IRA
Take a traditional IRA for example, a situation I am dealing with. If you take the dispersion then you, or in this case my POA Individual, will pay taxes on the entire amount this year as income. A better option would be to open an inherited IRA account with a brokerage house. Essentially this would allow you to control your income tax bill from this inheritance. Places like Schwab have no fee inherited IRA options. All you need to do is have the money transferred.
How Long Can You Defer Taxes with an Inherited IRA?
The secure act that passed earlier this year changed the rules around managing an inherited IRA. Previously you could manage it like it was your own, using RMDs to withdrawal funds.
With the passage of the law this was changed to a straight requirement to withdrawal the funds within ten years of death. (Note there are different rules for spouses where they can take over the account in certain scenarios). Unlike RMD you can pick and choose any period within the ten years to withdrawal as long as it is all gone in ten years. It could even all occur on the last day of the 9th year. So obviously some tax planning flexibility is now available.
Another item in our POAs inheritance was a death benefit from an annuity. You can take such a benefit as an inherited IRA or roll it into another annuity. I am still not a big fan of annuities. As such I would recommend taking it as an inherited IRA.
Anyway if you choose the annuity option you could delay taking it for up to 5 years from the death of the individual. And again you have ten years to exhaust the funds from date of death. As stated previously this article excludes spousal and minor child inheritance which are different rules.
Our POA Subject will pay no Income Taxes
The above rules are important for most people‘s tax planning. In the case of our charge, he has no other source of income. So the ten year rule allows us to maintain a point where he essentially pays no income tax on this money.
Annuities and Medicaid or Veteran’s Pensions- Some Concerns
Before we leave this part of the topic a warning on annuities. Besides my previously stated opinion there is another reason to avoid annuities for lower asset individuals. Should that individual ever need Medicaid an annuity may bump their income beyond the limits of eligibility. I suspect rolling funds into annuities would rarely if ever be recommended for an elderly low income individual as a result.
Anyway, that does it for beneficiary accounts. But what about accounts without beneficiaries and real estate? Well unless the individual setup some sort of trust these will flow through what is called probate. Probate is essentially a period where the state processes and proves the will of the estate. Typically a state will charge a fee for this process. In my own state the fee is 4% of assets. This is also where the state will validate or appoint an executor.
Sit and Wait
After that appointment there is a period of some time where all liabilities of the deceased need to be validated and all heirs need to be checked. This means typically you have a period of a year or so where the assets sit in probate before being released. Contrast that with the beneficiary process where things move within a few weeks to a month.
On the other side of the probate process typically these assets will pass to the inherited as a check or in the case of real estate as the property. So there are less questions about how you want something when inheriting out of probate. Our charge will inherit some assets this way as well, though all of the cash variety.
Real Estate Probate
A brief note on real estate. Technically real estate is probated in the county in which it is located. So the probate process starts in the deceased’s home state. Then the location of the real estate will execute its own probate on the property. Typically the property location will inherit will validation and heirs information from the main probate proceedings. But probate in a second state is still another step. Our charge did not inherit real estate, but I was reading about this during the process so I decided to add it.
Consult a Lawyer and Read Up On Your State Laws
And there you have it. The usual caveats apply that this post is for entertainment only. Do your own research on your states rules, as things change based on the state. Consult a lawyer as necessary.
Power of Attorney and Inherited Money, Added Complexities
Now my own situation was even more complicated then the above. Being only the Power of attorney means you have to prove that position to every financial organization you deal with. Often that involves a signed copy of their paperwork in addition to the generic one. (Kind of crappy if you signed a general POA early on and then when it is needed they ignore it!)
I Got Lucky, Incapacitated and Legally Incapacitated are Not the Same Thing
In our case our charge is not legally incapacitated, even if dealing with such complex decisions is beyond his current situation. As such I walked around this issue by having him sign the paperwork after I worked out the process and plan. If you can do this that would be my recommendation. You could be facing multiple signed, and often notarized, one time use pieces of paper otherwise. And frankly if they are legally incapacitated they won’t be able to sign that new POA anyway…
Have you ever inherited money or helped someone else to do so?