Between $1 trillion and $3 trillion will be transferred to heirs every year through 2050, according to a study by Accenture. Will you be one of the recipients? And if so, do you know the best ways to handle an inheritance?
If the amount is substantial, "people think 'now my life has changed — now what do I do?'" said David Mendels, certified financial planner and director of planning at Creative Financial Concepts.
Take a deep breath and do nothing for several months, apart from sorting out your feelings, he said. "This is more emotionally involved than a lottery ticket, because there was a person behind it," Mendels added. "Look at what this represents to you. It's not just a windfall," he said. "It's what you're being given by someone who's no longer here."
It's important to think about how you to deal with the bequest versus letting it just happen, according to Mendels, because moving too quickly can result in poor decisions, such as spending it all or taking advice that may be regretted later. It can be hard to say no, he warned, so plan on how you'll deal with ideas from friends and relatives on how to spend or invest the money.
Speaking of relatives, attorney Bob Karn, CFP and principal with Karn Couzens & Associates, warns heirs against fights with their siblings. He has learned through experience that, when siblings bicker, "there is no 'fair' and equal is not 'fair.'"
Unfortunately, families who don't fight are an exception, he said. To try to prevent family meltdowns, Karn has hosted intergenerational meetings where parents lay out their final wishes. After a loss, clients should let advisors be the "bad guys" to try to alleviate family strife, he said.
More from Investor Toolkit:
Advisors offer clients 'fatally flawed' advice
Investing with borrowed money can be a big win
Beware of online financial quick-fix stories
"We can lend rationality and some non-confidential background about the parents," Karn said. "In fact, I often tell heirs: 'Live your lives – don't plan on an inheritance.'"
It is helpful to follow a predetermined process when thinking about inherited money — especially when it is an amount that is significantly larger than you're used to, according to Susan Bradley, CFP, Certified Financial Transitionist and founder of the Sudden Money Institute.
"You don't want to be reactive and decide, for example, 'Let's go buy a boat!'" she said. "You want to take time to think about what you want to do and be responsive instead." Bradley advises that heirs make four lists of possible expenditures, under the following categories:
- Safety (medical expenses, insurance, home repair, personal transportation, etc.)
- Fun (vacations, dinners, etc.)
- Future (investing; i.e., money left untouched for at least five years.)
- Cushion (cash for true emergencies.)
Another, optional category could be charity, according to Bradley.
Make sure there's some money in each category, she added. Be free form, try to enjoy making the lists and then revisit them. It's not about putting equal amounts in each category but about prioritizing what the most important items are.
"From top to bottom [wealth-wise], we all struggle when we receive money that feels like free," Bradley said. "It doesn't feel like it has the same consequences as your paycheck."
When dealing with a life-changing amount, it is important to view the event through the lens of change management, Bradley said. "You need to deal with the human side of money first before the technical part," she added. "That's the opposite of what most advisors are trained to do."
Getting technical
Leon Labrecque, JD, CFP and managing partner and CEO of LJPR Financial Advisors, offered advice on the more technical aspects of an inheritance.
"Think of income, not of assets," he said. "We always try to frame an inheritance as 'You can get $40,000 a year for life', instead of 'You have $1.2 million'.
"We find the income argument seems to help frame the discussion."
Labrecque advises that heirs get their own estate plans in order, with, at a minimum, health care and financial powers of attorney and a will. They should also check that beneficiary designations are up-to-date and that deeds and all property are titled correctly. For larger estates, he said, a revocable living trust may make sense.
The new tax laws have a profound effect on inheritances, Labrecque said. "If you inherit a pass-through business, like rentals or small businesses, there are new rules," he said. "Inherit appreciated property and you get a special 'step-up' in basis. Inherit an IRA? You are subject to minimum distribution rules that generate ordinary income," Labrecque added. "Roth IRA? Congratulations, you won the tax-free lottery."
Labrecque cautioned that inheritances are tricky things. "They can take away our drive, they can encourage changes in behavior, and they can foster bad behavior," he said. "On the other hand, taking time to set our perspective can make it work and create a lasting legacy.
"But it takes the intention to do so."
— By Deborah Nason, special to CNBC.com
