Whether you're planning to leave a legacy for your children or expecting to receive one from your parents, inheritance can be one of the most significant financial events in a family's life. Done well, it can provide security, opportunity, and peace of mind for generations. Done poorly, it can create tax burdens, family conflicts, and missed opportunities.
Here in Oakland, Winter Garden, and throughout Central Florida, we work with families on both sides of this equation: parents who want to pass on their wealth thoughtfully, and adult children who want to honor that legacy responsibly.
Let's walk through what both generations need to know.
For Those Planning to Leave an Inheritance: Setting Your Family Up for Success
If you're in your 60s, 70s, or 80s and thinking about what you'll leave behind, you have more control over the outcome than you might realize. The decisions you make now can dramatically impact how much your heirs receive and how smoothly the transfer goes.
Tax Planning: Who Should Pay the Bill?
One of the biggest questions we hear is: "Should I pay the taxes now, or let my kids deal with it later?"
The answer depends on your situation, but here are the key considerations:
*Roth Conversions: Paying Taxes Now to Save Your Kids Later
If you have significant traditional IRA or 401(k) balances, your children will inherit a tax bill along with the account. Under current law, most non-spouse beneficiaries must empty inherited traditional IRAs within 10 years, which can push them into higher tax brackets.
Consider this example: You leave your son a $500,000 traditional IRA. He's required to withdraw $50,000 per year for 10 years. If he's already earning $80,000 annually, that extra $50,000 could push him from the 22% tax bracket into the 24% or even 32% bracket.
Roth conversions during your lifetime can solve this problem. You pay the taxes at your current rate, and your children inherit tax-free money. This is especially powerful if:
- You're in a lower tax bracket than your children will be
- You're not spending all your RMDs anyway
- You have other assets to pay the conversion taxes
Florida's Tax Advantage
Living in Florida gives you a significant advantage here. You don't pay state income tax on Roth conversions, while your children might live in states that do. Converting your traditional IRA to a Roth in Florida could save your family thousands in state taxes.
Life Insurance as a Tax Solution
Some families use life insurance to pay the tax bill on inherited retirement accounts. You take RMDs from your traditional IRA and use part of the money to pay life insurance premiums. When you pass away, the life insurance pays your children tax-free money that they can use to pay the taxes on the inherited IRA.
The Value of Clear Communication
Here's something we see too often: parents spend years carefully planning their estate, but they never talk to their children about it. The result? Confusion, family conflicts, and sometimes decisions that go against the parents' wishes.
Have the Conversation
Your adult children need to know:
- What your wishes are for the inheritance
- Whether there are any strings attached or expectations
- If you've planned for specific purposes (grandchildren's education, family business, charity)
- What the tax implications will be
- Who your financial team is and how to reach them
This doesn't mean you have to share every detail of your finances. But your children should understand enough to make informed decisions when the time comes.
Consider a Family Meeting
Many families find it helpful to have a formal family meeting with their financial advisor. This gives everyone a chance to ask questions, understand the plan, and discuss any concerns while you're still here to provide guidance.
Timing Matters
The timing of when your children receive their inheritance can be just as important as how much they receive.
Age and Maturity Considerations
A 25-year-old might not be ready for a large inheritance, while a 45-year-old with a family and established career might handle it more responsibly. You can structure trusts to distribute assets at different ages or life milestones.
Market Timing
If your children will be inheriting investment accounts, consider the market timing. Inheriting during a market downturn might actually be beneficial due to the "stepped-up basis" rules, while inheriting during a market peak might mean higher taxes.
For Those Receiving an Inheritance: Making the Most of Your Family's Legacy
If you're expecting to receive an inheritance or have recently received one, you have an opportunity to honor your family's legacy while securing your own financial future. But inheritance can also be overwhelming, emotionally complex, and filled with potential pitfalls.
First Steps: Don't Rush Into Anything
Take Time to Process
Receiving an inheritance, especially after losing a parent, can be emotionally overwhelming. Don't feel pressured to make immediate decisions about the money unless there are time-sensitive tax implications.
Understand What You've Inherited
Before you do anything else, get a complete picture:
- What types of accounts or assets did you inherit?
- Are there any immediate tax implications?
- Are there Required Minimum Distributions you need to take?
- What are the rules for the specific accounts you've inherited?
Assemble Your Team
If your parents worked with a financial advisor, start there. They'll understand your parents' strategy and can help you navigate the inheritance rules. Note: you don’t need to use your parents' financial advisor as ultimately, you will want to work with someone who understands your unique needs, but your parents advisor can be a good starting (and maybe a good fit). You might also need to consult with a tax professional, especially if the inheritance is substantial.
Avoiding the "Lottery Winner" Syndrome
Studies show that a surprising number of lottery winners end up worse off financially within a few years. The same can happen with inheritance if you're not careful.
Common Mistakes to Avoid:
Lifestyle Inflation
Just because you inherited money doesn't mean you should immediately upgrade your lifestyle. A $200,000 inheritance might feel like a lot, but if you use it to buy a more expensive house with higher monthly payments, you might actually be worse off financially.
Family Pressure
Extended family members might suddenly have "investment opportunities" or financial needs. It's okay to say no, and it's okay to take time before making any family loans or gifts.
Emotional Spending
Some people cope with grief by spending. Others feel guilty about their inheritance and give it away impulsively. Both can lead to financial regret later.
Smart Strategies for Inheritance Recipients
Pay Off High-Interest Debt First
If you have credit card debt, student loans, or other high-interest obligations, paying these off first often provides the best "return" on your inheritance.
Build or Boost Your Emergency Fund
Having 3-6 months of expenses in an emergency fund provides security and peace of mind. If your inheritance allows you to fully fund this, it can be life-changing.
Maximize Tax-Advantaged Accounts
If you haven't been maxing out your 401(k) or IRA contributions, you could use part of your inheritance to cover living expenses while increasing your retirement contributions to the maximum.
Think Long-Term
Remember, this money represents your parents' life's work. Honor that by making decisions that will benefit your family for years to come, not just provide immediate gratification.
Understanding Inherited Account Rules
Inherited IRAs
If you inherit a traditional IRA from a parent, you generally have 10 years to empty the account. This doesn't mean you have to take equal amounts each year, but you do need a strategy to manage the tax impact.
Inherited Roth IRAs
These are typically tax-free to you, but you still have to empty them within 10 years. Since there are no taxes, you might want to leave these alone as long as possible to maximize the tax-free growth.
Taxable Investment Accounts
These receive a "stepped-up basis," which means you inherit them at their current market value, not what your parents originally paid. This can eliminate capital gains taxes if you sell soon after inheriting.
How LaPorte Financial Can Help Central Florida Families
Whether you're planning to leave an inheritance or expecting to receive one, we work with families throughout Oakland, Winter Garden, and the Greater Orlando area to make sure these transitions go smoothly.
For Those Planning to Leave an Inheritance:
We help you evaluate Roth conversion strategies, coordinate with your estate planning attorney, and facilitate family meetings to ensure everyone understands the plan.
For Those Receiving an Inheritance:
We help you understand what you've inherited, develop a strategy for managing inherited accounts, and integrate your inheritance into your overall financial plan.
Both situations require careful planning, clear communication, and professional guidance. The decisions you make can impact your family for generations.
Frequently Asked Questions About Receiving an Inheritance
Q: How long do I have to decide what to do with an inherited IRA?
A: You generally have until December 31st of the year following the original owner's death to make certain elections (like disclaiming the inheritance). However, if you inherit a traditional IRA, you have up to 10 years to withdraw all the money, giving you flexibility in timing the withdrawals to manage tax impact.
Q: Do I have to pay taxes on money I inherit?
A: It depends on what you inherit. Cash, regular investment accounts, and Roth IRAs are generally tax-free to inherit. Traditional IRAs and 401(k)s will be taxable when you withdraw the money. Life insurance proceeds are typically tax-free. Florida has no state inheritance tax, which is an advantage for families here.
Q: Should I keep my parents' financial advisor or find my own?
A: This depends on your comfort level and financial situation. If your parents' advisor understands the inheritance plan and you have a good relationship with them, it often makes sense to work together, at least initially. They can help you navigate the inheritance rules and understand your parents' strategy. You can always transition to someone else later if needed.
Q: What if I inherit my parents' house but can't afford to keep it?
A: You're not required to keep inherited property. You can sell it, and thanks to the stepped-up basis rules, you'll typically owe little or no capital gains tax if you sell relatively soon after inheriting. If you want to keep it but can't afford the upkeep, you might consider renting it out or discussing with your siblings about sharing costs.
Q: How do I handle inheritance if I have siblings?
A: This can be complicated, especially if the inheritance isn't divided equally or if some assets are easier to split than others. Communication is key. Consider working with a financial advisor or mediator who can help facilitate discussions and ensure everyone understands their options. Sometimes it makes sense to sell assets and split the proceeds rather than trying to divide assets themselves.
Q: What should I do if I inherit retirement accounts and I'm already retired?
A: If you're already taking RMDs from your own accounts, inheriting additional retirement accounts can push you into higher tax brackets. Consider strategies like spreading the inherited IRA withdrawals over the full 10 years, doing partial Roth conversions, or using Qualified Charitable Distributions if you're charitably inclined.
Q: Can I disclaim (refuse) an inheritance if I don't want the tax burden?
A: Yes, you can disclaim an inheritance within nine months of the original owner's death, as long as you haven't taken any distributions or exercised control over the assets. The inheritance would then pass to the next beneficiary in line (often your children). This strategy is sometimes used when the inheritance would create significant tax problems.
Q: How do inheritance rules differ for spouses vs. children?
A: Spouses have more options when inheriting retirement accounts. They can roll inherited IRAs into their own IRA or treat the inherited IRA as their own, which allows them to delay RMDs until they reach 73. Non-spouse beneficiaries (including children) must generally empty inherited IRAs within 10 years and cannot roll them into their own accounts.
Ready to discuss your family's inheritance planning? Whether you're preparing to leave a legacy or managing one you've received, LaPorte Financial is here to help Central Florida families navigate these important decisions.
*Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.