Chances are that every person, at some point in their life, will receive an inheritance. It could be small; it could be big. It could come during high-earning years or well into retirement. It could be one account or many accounts. All these variables have an impact on how the inheritance should be handled and decisions typically need to be made promptly. However, almost universally true for anyone receiving an inheritance is that someone they cared about is no longer with them. They are now grieving while also needing to make important financial decisions. For this reason, we highly encourage you to tell your relationship manager or wealth planner that you are receiving an inheritance as soon as you are made aware. We can quickly determine your first steps and guide you through the process. Let’s look at some questions that might arise, specifically when it comes to the type of account you inherit.
Do I pay taxes immediately?
No, most states (including Oregon, Washington and Idaho) do not impose an inheritance tax. This is not to say that an inheritance is tax-free though. Tax is paid later depending on the account type. A taxable brokerage account will receive a step-up in basis, meaning the cost basis for the account becomes the current market value and taxes are only paid when the beneficiary sells something at a gain. There are no rules as to how or when you must distribute the account, so you could theoretically leave it invested forever or even use it as a gifting source if you wish. Inherited IRAs are a different story and have a bit more nuance.
I inherited an IRA, tell me about this nuance…
An inherited IRA (from a non-spouse) can typically go one of two ways depending on whether the decedent was at the age of Required Minimum Distributions (RMDs). If they were, then as a beneficiary, you too will have RMDs from the account. If not, then likewise you do not have RMDs. In either of these scenarios, the account has to be distributed within ten years and all distributions are taxed to the beneficiary as earned income. This is why working with your Becker team to manage the withdrawals in a tax-efficient manner is crucial, so you don’t find yourself with an unpleasant tax bill at the end of year ten. We are experts at finding the optimal distribution schedule based on factors including age, income, current and future tax brackets, etc.
What about an inherited Roth IRA?
A Roth IRA is a slightly different story and perhaps one of the best things to inherit. While the account still must be distributed by the end of the tenth year, withdrawals are tax free and there are never any RMDs. This means you could leave the account invested and growing for the full ten years and then cash it out completely tax-free. Or, you might be trying to stay within a certain tax bracket for those ten years and don’t want to create unnecessary income from your traditional retirement accounts. You could essentially create a tax-free income stream for yourself from the inherited Roth IRA. There are numerous strategies to consider and this is again why we encourage you to work with your wealth planner.
Receiving an inheritance is by definition bittersweet. How amazing that someone cared for you so much that they selected you as their beneficiary and now you have a potentially life-changing windfall. But of course, there is also the sadness of no longer having your loved one with you. When you find yourself in this situation, please let your Becker team help guide you through the financial side of it so you can focus on remembering and honoring your loved one. We also hope this can serve as a reminder to review your beneficiaries and estate planning documents so that your inheritance is left just how you intend.