Episode 514 – Will You Inherit Family Money?

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John Walker
Hey, welcome to the Your Life Your Wealth podcast. I’m John Walker, Regional Vice President at Mercer Advisors. Always a pleasure to be with you. And today, we’re gonna talk about, I think something really important and a, and a bit timely. I’ve been having this conversation with a lot of families recently, and I, I, I, I think it’s, uh, it’s really a relevant topic and especially with some, some changes that have recently happened in the law, and that’s managing an inheritance. You know, how do you manage an inheritance in the proper way, because candidly, it can really change your life, right?

There’s a million stories all the time in the press around like somebody who passed away quietly, you never, never knew, and they kept everything secret and they leave a fortune behind, and most people are not experiencing that, but it is really, really common now and becoming more so as

The great wealth transfer, as it’s been dubbed, of the baby boomer generation passing down what’s expected to be somewhere close to $84 trillion by 2045 according to Northwest Mutual Studies. And so that’s a tremendous amount of assets that are going to move from one generation to another.

And certainly, what that looks like for you and your family could be wildly different from others, but it is really, really important that you manage that properly because there are steps you need to take and, and the decisions you make can be really consequential. So to help me have that conversation and go through some helpful advice around navigating an inheritance in a fiscally responsible way is, uh, my good friend and colleague here, CERTIFIED FINANCIAL PLANNER® and market leader, Mr. Jason O’Meara. Jay, thanks for joining me again.

Jason O’Meara: Of course, John. Thanks for having me back. And maybe it’s just a recency bias, but I do feel like we’ve collectively and individually been having this conversation quite a bit lately, and it, you know, really focusing around um, you know, certainly since here at Mercer Advisors we do estate planning, so we get a lot of introductions to new families who are looking or have questions in this space.

Maybe it’s simply just a product of that, but it is really important that from a financial planning perspective that you have a good plan in place for your beneficiaries. But for those that are receiving the benefit of this inheritance, it’s really important that you, that you manage it, right? Yeah, and manage it prudently, right? And so, um, I thought it’d be helpful to kind of just go through some of the things that you really need to be thinking about if you are to inherit, you know, any size assets. I think the first step is make sure you understand what you’ll actually be getting because many families have, you know, a litany of different types of assets that you might be inheriting it, whether it’s, and they’re all treated a little different, right?

Jason O’Meara
Exactly, right. That’s the big thing.

John Walker
So step one is identify what it is, right? So you’re going to have things like potentially real estate, investments, cash, retirement accounts, accounts, life insurance, real assets like cars and, and, you know, contents of homes, you know, things that are, you know, that have to be dealt with and you have to figure out where all these things are, how they’re titled, who owns them, and what are the consequences, and tax treatment of all of these different things, right?

Jason O’Meara
Right. And that’s, that’s the hardest part, right? Cause, and, and this is also why, you know, planning is so important, you know, it, it’s, you don’t wanna wait till, you know, something happens to mom or dad to start figuring out what assets they have that is gonna come to you, right? You need to know these things earlier. One, there’s no like log out there telling you where all their accounts are, unless your parents have put it together, you know, if you are inheriting. If you are on the other side of that, and you know you’re going to be leaving an inheritance.

It’s best to have stuff all in one spot.

[4:34] John Walker: yeah, right, one place. There’s some, some merit to that consolidation or at least having everything documented, right? And so,…

Jason O’Meara
I don’t mean like have all your stuff in 11 place. I mean like, you know, have a list, yeah, you know, in a fireproof safe or something, like, you know, just a list. Here’s where all my accounts are, you know.

John Walker
I mean, because it could literally take months and, and countless hours and potentially countless dollars to to track down assets, right? And, and particularly if you’re doing it with the help of, you know, an attorney or if the estate is really large, you know, there, there are consequences to that and.

Making sure that you understand, you know, if you are the beneficiary, was there a will and or, or, or a trust that I need to follow? And, what are the rules and, and what does it say? Because if there isn’t, it’s a whole different process that could be incredibly costly and time-consuming. You know, it could take months and months and months to settle an estate without a will.

John Walker
And costs, you know, thousands of dollars in fees. So, you know, step one, what are the rules? How are you receiving the benefit of these? And then what are the, and, and, you know, are you, are you aware, this is probably step two, once you know what you’re getting and how it’s titled.

You have to start thinking about what you’ll owe in potential taxes, right? And it’s, as you said earlier, it’s very much dependent on the assets that you inherit, what you may or may not have to pay.

Jason O’Meara
The reality of it is most people, most, most people out there will not be affected by the federal estate tax, right? So, uh, got to look at consider things around where you live and what state and how are the estate rules in your, in the state you live in, right, some states have nothing. Some states have hefty estate tax. Some people, some states have inheritance tax. There is a state out there that has both.

John Walker
Yeah, yeah, I mean, just for, for transparency’s sake, right, the new, the new tax law provides every individual a $15 million current, current year 2026 $15 million gift and estate tax exemption per person, right? So collectively $30 million for a married unit.

John Walker
That’s a significant amount of federal estate tax exemption, right? But as you rightly point out, that doesn’t mean you’d be immune from estate taxes or immune from tax, right? We’re going to talk a little bit about the difference between them, but you’re right, you know, you and I both live in Pennsylvania. Pennsylvania has a 4.5% inheritance tax currently on the books, right? So regardless of assuming, assuming direct lineage, exactly, assuming direct lineage, New Jersey doesn’t have one at the immediate beneficiary level, right, the lineal spouse or child, but it goes beyond that and it gets pretty onerous pretty quickly.

It can jump pretty, pretty quickly, right? So how are you inheriting this? Who are you inheriting it from? If you inherit it from an aunt or uncle in the state of New Jersey, there’s a good chance you’re going to have a state level inheritance tax. And as you said, each state is specific. Some states have both, some have none, but it’s really critical you understand because, you know, a couple of percentage tax on a, on a significant asset level, and it’s not just the liquid assets, right? It’s the entirety of the estate. You know, if you’re being gifted or you’re inheriting a piece of real estate that’s of significant value, you have to start thinking about how are you going to pay a tax on an illiquid asset as an example.

We’ll spend a little more time on that later because there’s a big difference, Jason, between taxable assets and qualified assets, things like retirement accounts, etc. So we’re going to have to spend a little time talking about that. Why don’t we cue in first on what has a little bit of a currently has a relatively simple process with, with, with when it comes to taxation, and that would be your taxable investments.

These are things like if you were to inherit stocks, bonds, mutual funds, any other investments that are in a taxable account, meaning post-tax dollars, not a retirement account, and a taxable investment account.

Under current law, there’s a really advantageous generous tax break known as a step up in basis, and what that means is the cost basis for those taxable assets you inherit, stocks and mutual funds, etc. are stepped up to the investment value on the day of the original owner’s death. So maybe you can explain it with, you know, give us some example.

Jason O’Meara
So when I’m explaining this with families I work with, I usually tell them it’s as if they purchased the stock on the day that the owner passed away. So if you know, somebody’s inheriting the money from their mom and their mom passed away January 1st of this year. It’s as if they bought that investment on January 1st of this year, and it basically is, you could sell immediately.

So let’s say you have a situation where you own, you’ve owned, I don’t know, pick a stock for the last 20 years, and you bought it for $500 and now it’s worth $10,000 right? If you were to sell it while you were alive, you would have to pay that $9500 worth of capital gains, right? But if you were to pass away and your beneficiary, whoever that is, inherits it, that, that $9500 in capital gains goes away basically, right?

So we’re always looking at how do we, how do we manage these things, especially as clients get older, um, and they have concentrated positions or whatnot, how do we manage this as tax efficiently as possible. There’s a lot to say with unless you have no faith in that investment to wait.

You know, wait and get that stuff up and let your, let whoever inherits it, let them, let them sell it, uh, and not pay the tax on it. So, it’s something, but it’s something to consider cause that may change the way you, you plan as you get older. Uh, it might change the way you gift, cause if you were to gift that stock while you’re alive, that cost basis follows.

So you know it’s same, same example bought it for $500 is now worth $10,000. You gift it to your kid and your kid sells it, they’re paying capital gains on that $9500 that it’s appreciated. So having a strong plan around gifting and managing your taxable investments, um, especially as you get older, is paramount. It’s very important to make sure you’re not causing any additional taxes than what you actually need to pay.

John Walker
Yeah, no, absolutely right, and it’s really important that people understand how this works. And if you are to receive the benefit of an inheritance like this, you need to work with whoever the investment custodian of those assets is and notify them of the date of death to ensure that you get that step up, um, because it is a very favorable tax treatment, right? It can eliminate what we’re seeing – more and more really sizable capital gains for families that have had long-term investment portfolios, right? We’ve been very fortunate to see a lot of growth in the, in the, you know, you know, the markets over the last several decades here, right? So a lot of folks, if this is, you know, money that’s been accumulating for long periods of time, you can eliminate a lot of that tax liability.

But let’s talk a little bit about Jason. What we’re seeing more and more of as well, because a lot of folks have a lot of their assets in retirement accounts, right? They still, they pass away and they still have money in their traditional IRAs, perhaps even in a 401k, um, and the rules around inheriting a tax-deferred retirement plan are very, very different, right? And so it’s critical to explain sort of those differences in the tax treatments because who you are as the beneficiary also determines how some of this works, right? So, um, if you are the spouse, you can, and are the recipient of a tax-deferred retirement plan, you have options, right? You can potentially roll the money into your own IRA and postpone any distributions and taxes until you are at required minimum distribution age. Um, but if you are a sibling or a child of who is receiving these benefits, the rules changed and you really need to understand how they work, right?

Jason O’Meara
And it depends. Go back in time like two seconds, John, like go back in time a couple of years when this rule changed, there was very little guidance. So even if you think you know what the rule was five years ago when this changed, the rules are are, are, I’m not gonna say completely different but slightly different, and there’s some, there’s some areas that you can trip over that we need to be sure you’re doing it the correct way. Uh, for example, John had mentioned that 10-year rule that applies if you inherit a traditional IRA from mom and dad.

Uh, if mom and dad had already started taking their required minimum distributions, you now have to continue those required minimum distributions during that 10-year period and still have the account empty at the end of that 10th year, right? So there’s some caveats that didn’t exist two years ago. We didn’t have to do those required minimum distributions.

It’s just there was no guidance around it, so the IRS kind of gave us a couple of years of, all right, you got those for free, now let’s go. This is how it has to be done. Um, but it’s, it’s, I say that to say it’s confusing. And if you don’t take a required minimum distribution, that’s a 25% penalty. They penalize you 25% of the amount you were supposed to have taken out.

So, you know, it’s, it’s costly to not do this the right way, which is why I always say don’t go at this alone. Work with an advisor. Work with your advisor to determine the right way to do this. This is, you know, this is how we make a living. This is what we are constantly learning on and making sure we’re doing right for families. So there’s a lot of moving parts to that.

John Walker
Yeah, yeah, and that’s if you, you’re absolutely right, Jason. And, and so if one of the things you inherit is a traditional IRA, you really need to understand what rules apply to you. So certainly working with an advisor, working with a tax professional to help you understand the tax consequences. Jason, another important thing to consider with a traditional IRA is that when you receive those funds, whether you have to start taking required minimum distributions or not.

There is a requirement that the assets be withdrawn by the end of the 10th year. All of the assets that are withdrawn from that traditional IRA structure are taxable as income for the recipient of that, right? So if you are the beneficiary of this IRA, you have to be really aware of the fact that that distribution that you, you are taking is going to be added to your other sources of income, right? So your salary, your bonuses, your investment income, whatever you have going on in your family on your tax return, this just gets added to that. This could be a tax bite, right? A pretty significant one depending on the, the income that you’re currently earning. So really important to understand that you are going to be taxed at your income levels. It doesn’t matter what your, you know, your great uncle who left it for you. Maybe he was in a low tax bracket, but you are going to get taxed as income for that additional income that you are required to take, right?

Jason O’Meara: And there’s things to consider. Maybe you are past 65 and you are on Medicare and this extra money, this extra money coming out may put you into a higher, uh, bracket for your, uh, IRA, which is the adjustments on your Medicare, right? Uh, maybe you’re not at 65 and maybe you aren’t working and maybe you have the Affordable Care Act, the insurance for the Affordable Care Act. This may affect your subsidies. So there’s, there’s things to consider when you’re inheriting these assets.

Now listen, pay your taxes, take your money. Don’t let’s, let’s not say don’t inherit it, but you at least need to know what you’re getting into. Exactly right, right. Or maybe it makes sense to take a hit in year one, John, right, and just empty the account, right? That’s what I’m saying it’s important to work with your, with your CPA, work with your plan, work with your advisor, and just determine what’s the best approach to inherit this asset.

John Walker
Yeah, yeah, absolutely. Also recognizing that the rules that apply to traditional IRAs are slightly different when it comes to Roth IRAs, which if you are fortunate enough to inherit a Roth IRA, you’ll still be required to deplete the account, you know, within the 10 years, but there are no required minimum distributions and the withdrawals are tax-free.

And so a big difference to understand, did you, the characteristics of the account that you inherited it, was it a traditional IRA or 401k, a, a pre-tax qualified account, or is it a Roth where it’s post-tax dollars and they won’t be treated as income, right? So determining how to do that, you know, what are your withdrawal strategy options, right? And, and so, you know, working with professionals to help you identify that is really, really important if you get the luxury of being a part of the process that plans prior to receiving the benefit of a, of an inheritance like this.

There are some steps you can take, right, Jason? We work with families all the time here at Mercer Advisors around the estate planning sort of 2.0, right? It’s not just making sure you have documents in place. It’s modeling out how do we optimize your taxes while you’re living, but also the tax treatment that your beneficiaries will receive. And so when we talk about this, if you know you are n the other side of this coin, and you’re thinking about how to effectively get your assets to your beneficiaries, this is where doing some, some work and some modeling out some strategies around things like Roth conversions and other opportunities to say, how do, what, how do I want my children, nieces and nephews, etc. to receive these assets, because if there is an opportunity to position them in a more tax advantaged way it may be worth considering, right?

So it is, it is often more, not every, you know, maybe not every time, but it’s often more tax efficient for the beneficiary certainly to receive Roth assets versus a traditional IRA. Correct, correct. That requires some work and some, some considerations and some planning on the, the decedent side, right? So if you are thinking about this, it’s really important to understand, you know, the impact that taxes are going to have not just at the, you know, the inheritance tax level, but the tax characteristics of what your beneficiaries will inherit, right?

Jason O’Meara
And one other, one other caveat to this before we, we, we move on to the next type, um, if you’re listening to this now, just please ensure that your beneficiaries are correct on your 401ks, your IRAs, your Roth IRAs. It is so much easier to have an individual inherit this account versus your estate.

You know, we want to make sure that it’s a named individual that skips probate, that goes directly to them. Um, it’s just a better way for them to inherit it. Um, also, it’s not always a good idea if you have a traditional IRA to say, oh well, Kid A will inherit this, and I’ll trust them to do the right thing and distribute it out to Kid B and C. Um, just try to make sure that it’s as easy as possible for your beneficiaries.

John Walker
Yes, that’s a great point. And, and, and yeah, really important to just have everything documented properly. The other thing that we would want to talk about, Jason, is kind of the other types of assets that that people often inherit. One of them is a, is a, is a home, right? Real estate. It’s another interesting one where we’ve seen a lot of appreciation, right? A lot of real estate has appreciated significantly over the last several decades. If you’re fortunate enough to be in the, in the part of the country where that has happened, you know, some real estate has skyrocketed across this country. And so, understanding what happens if you inherit that, uh, is really, really important, right? So the first thing I would share is that real estate currently is treated in a similar manner to taxable investment assets in that you get a step up in basis to the value of the date of the owner’s death. That’s not as simple to calculate as maybe something that’s a tradable equity on the US stock market, but it can of course eliminate a significant amount of capital gains taxes that would be due had the had the property been sold prior to death. So I’ll give you an easy example. If you, you just, you know, some, if your, if your uncle purchased a property for $150,000 initially and by the time you inherit it, you know, it’s worth $300,000.

The basis is stepped up to that $300,000. So you get that immediate tax break, right, of the capital gains that would be reduced, you know, should you choose to sell the property later. But that’s probably where it gets a little more complex, right? So understanding that keeping and maintaining a home, right, right, right, is a little more challenging than maybe holding on to a stock portfolio, right? Exactly, because that’s the hard part, right? It’s an illiquid asset. It takes time, you know, even if you even put up for market immediately.

Jason O’Meara
And it’s one of those sales where over the over the course of a weekend you get your offer, you accept it, you know, even if you’re doing a quick close, that’s still a couple of weeks, right before you get the assets for the cash. More than likely it’s going to be a longer close than that, and you may have to maintain this home for a month or two.

Assuming everything goes smoothly, or it could take longer if it doesn’t sell right away, right?

John Walker
Yeah, and that’s if, you know, so maintaining the home, paying the mortgage, paying the real estate taxes, maintaining the insurance, paying the utilities, right? There’s a lot of soft costs potentially to inheriting real estate, and as you said, it could be weeks, months. That’s if you decide to sell it. If you decide to keep it, now you’ve just added, you know, all of these soft, soft costs for however long you plan to maintain the property, right?

So recognizing if you’re aware that you’re going to be inheriting real estate, it might be helpful to know like is there still a mortgage, you know, what are the real estate taxes, who’s who’s the homeowner’s insurance with and what does that cost, you know, what’s a typical monthly utility bill for this, for this property, right, because…

Jason O’Meara
…You know that’s a lot. There’s a lot of, a lot of variables.

John Walker
There are, and it’s not a, it’s not a liquid asset, right? It’s not something that will, you know, it maybe, it may not be the most tax efficient way, but if you, if you had, you know, inherited a stock portfolio and you needed to raise some cash, well, you can just sell some of the stocks, right? Like they’re, they’re tradable. They’re tradable on a day to day basis and there’s not a cost typically to holding them, right? You’re not paying a mortgage to hold the stock portfolio. So, you know, if you get this, this real estate and it costs $5,000 a month to maintain.

Well, were you prepared for that, right? Is that something that was a part of your budgeting for the benefit of inheriting, you know, a really nice piece of real estate? That’s something that’s really, really important to consider. So, uh, again, a part of the evaluation process and something that you need to, to be aware of. Um, Jason, one of the other things that’s often inherited is the benefit of a life insurance policy. Also treated uniquely for tax purposes.

Jason O’Meara
Probably the best treatment for tax purposes if you listen to every insurance company out there, they will tell you they’ll put it on the commercial.

John Walker
Yeah, exactly. It generally isn’t taxable as income. There are some exceptions, but, but largely it is not taxable as income, um.

It, depending on the structure of the life insurance, it could be included in the estate for determining own state estate taxes really depends who owns it, um, but generally, um, you know, you need to understand how is the payout going to be calculated, um, because what the tax treatment is different if it’s paid out as a lump sum rather than in installments, right? So, so understanding what are you getting? What are you receiving? How is the payment going to be distributed to you.

Jason O’Meara
I, I would say, I would say 99 out of 100 are a lump sum most of the time. Here’s a check, right? Um, you know, sometimes you’ll see the insurance company basically give you a checkbook with an interest rate, uh, you can just write checks against, um, but even then you write yourself one check and there you go. Uh, but as John had mentioned, it’s not, it’s usually that the benefit itself is income tax free, but any interest that gets earned, if you do an installment or if you’re in one of those quote unquote checkbooks, right, any of that would be income tax. It would be taxed as ordinary income, you know, um.

The big, the benefit of a life insurance policy is instant liquidity. So as soon as you have a death certificate, you submit that claim. Usually within a week you have a check. It’s quick, right? Where we, I like, where we like to see life insurance paired is either for young people who are looking to kind of, you know, John, John and I have life insurance cause we’re still working. We’re looking to secure our, our income if something were to happen to us, right? Um, starts to generally fall off as you, as you get older. But most importantly, if you have an uneven estate like a business, you’ll see people have life insurance because one, maybe one kid wants to work in the business, the other kid wants nothing to do with it. So one kid inherits a business, the other one inherits an equal amount of cash, you know, as a life insurance policy. So estate equalization. But the the reality of it is, depending on how that, when I said depends on who owns the policy, is, is it owned inside of a trust, like in, like an irrevocable life insurance trust, right? Then it could potentially not be part of the estate tax.

You know, it would not be part of the calculation for the estate tax if it’s owned by the individual who’s insured, then almost 100% of the time it is part of the estate tax calculation. So you’ve got to consider that where, you know, where you live and how that’s all played out, how it all plays out, so.

John Walker
Yeah, really, really important to understand again, as you’re hearing over and over again with all these different types of assets you can hurt, you have to understand exactly what you’re getting, how you’re receiving it, and what that tax treatment is going to be so you can be prepared.

Jason O’Meara
Yes, just having the knowledge around that stuff, John, it just eliminates mistakes. The reality is you only really, you get one shot at this. There’s very few times you get a redo on any of these things. So if you inherit it wrong from the beginning, it’s an uphill battle from there.

John Walker
So, Jason, it’s really important for our listeners to understand that if you are going to be the beneficiary of an inheritance, it’s critically important to know what you’ve inherited, the tax treatment of what you’ve inherited, the rules governing the type of asset you inherited, right? And to work with professionals if needed to, to get this right because it can be time-consuming and costly, and they could be really, really expensive mistakes if you don’t navigate this properly. It, as you said, you kind of get one crack at this, and, you know, taking some time to be prepared can really make it a little bit of an easier process. Jason O’Meara, CERTIFIED FINANCIAL PLANNER® and market leader here at Mercer Advisors, thanks so much for joining me today.

Jason O’Meara
Yeah, thanks, John. Thanks for having me back.

John Walker
Be sure to join us next time when we talk about how inheriting the family money can either make or break you and dive deeper into the emotional and financial turmoil that inheriting wealth often causes within a family. If what we talked about today though, has you thinking about inheritance you might be getting or has you asking questions about how to better prepare for this. We’re always here to help. Give us a call anytime at 215-558-3500. That’s 215-558-3500. Or you can email me at jwalker@merceradvisors.com. That’s jwalker@merceradvisors.com. I’m John Walker, Regional Vice President at Mercer Advisors. Thanks so much for listening to the Your Life Your Wealth podcast. See you next time.

If you’re interested in learning more about applying the principles we discussed to your personal financial circumstances, please visit Cordasco Financial Network at CFNplan.com.