Inheritance Management: Smart Steps When You Receive a Financial Windfall

Many of us have likely daydreamed about what we’d do if our “ship came in.” Imagine getting a certified letter from a law firm informing you that a wealthy relative has died and left your sizeable fortune. Suddenly, you are in possession of a sizeable financial windfall. What would you do?

You’ve probably heard the joking responses: “Pay off my debt as far as it would go”; “tell my boss where to get off”; and other similar (mostly unserious) ideas. But for those who do actually become responsible for “sudden wealth,” at some point the realization settles in that responsibly managing a large inheritance is a serious matter. Sadly, many who do find themselves in the position of receiving a financial windfall aren’t able to handle the task; according to some estimates, about a third of those who win significant amounts in lotteries, for example, eventually end up in bankruptcy.

What should I do first when I receive an inheritance?

So, how can you avoid the pitfalls and capitalize on the benefits of a financial windfall? Fortunately, there are some steps you can take that can greatly increase your ability to exercise good stewardship of your newfound wealth and build a strong foundation for the future financial wellbeing of yourself, your family, and perhaps even important causes that you care about.

1. Don’t get in a hurry. This is maybe the most important advice of all. Sudden wealth often creates a false sense of urgency: family members may have opinions; financial salespeople may appear; the pressure to “do something” with the money can feel immediate. But don’t yield to this impulse. Instead, when you’ve been creditably informed that you are receiving a large inheritance, the first thing you should do is take the time to understand the basics: what form the inheritance will take (it makes a big difference whether you’re inheriting cash, listed securities, real estate, or assets in some other form); what terms are attached (Is it in the form of a trust, which may govern the timing and amount of your receipt of the assets?); and, of course, the current fair market value. Avoid making any quick decisions, especially around spending, paying off debt, buying things for family members, or even investing. Remember that the main advantage of having money is that it gives you options; take plenty of time to carefully consider as many options as you can before taking any action.

2. Recruit your team. If you suddenly learned that you were receiving the responsibility of running a large business that you knew little about, what would you do? Most likely, you’d try to surround yourself with knowledgeable advisors who could help you keep the enterprise running smoothly and profitably. Well, in effect, managing a large inheritance properly is very much like running a business; you must make decisions that will not only preserve the assets but also encourage them to grow. With very few exceptions, those in this position should avail themselves of the best and most trustworthy experts they can find, including a CPA, a qualified estate planning attorney, and a professional, fiduciary financial advisor or wealth manager. You need a team that can combine talents to give you solid, coordinated advice about taxation, investment management, estate planning considerations, and other vital financial matters. Having the right team in place, in fact, may be your best defense against making hasty decisions that aren’t in your long-term best interest.

3. Make a plan. Even if it eventually requires amendment and revision, a plan is essential as you begin managing your inheritance. With the assistance of your team, your plan should take into consideration your current situation: your debt, your assets, and your goals for the future (whether those are focused on higher education for children, starting a new business, retirement, or all of the above). Once you know where you are right now, you’ll have a better way of determining the most advantageous means to deploy your newfound wealth. Depending on the specifics of your situation, your first priority may be to pay down high-interest debt; or to set up an education fund; or to make a necessary purchase that will improve your life or provide new opportunities. You may even decide to make a donation to a valued cause or establish your own charitable foundation. But it all starts with understanding where you are and strategically deciding the best way your inheritance can help you get where you want to go.

4. Continue to educate yourself. Part of your new responsibility as the “CEO” of your new “enterprise” is to learn as much as you can about finance, investment, taxation, estate planning, and other important financial topics. Understand: your goal is not to become a lawyer, a CPA, or a finance guru, but you should aim to become an informed consumer of the advice and guidance you receive from these professionals. In other words, you don’t have to go back to school and get any advanced degrees, but you should make it a habit to keep updated on financial and economic news, changes in the tax code, and other current developments that could affect your financial strategy.

Inherited IRAs or other retirement accounts and the 10-year distribution rule

Because IRAs and other retirement accounts include a specified beneficiary (the recipient of the funds in the event of the account owner’s passing), these accounts are often passed to a child or other heir. When this happens, it’s important to know the tax rules around how an inherited IRA or other tax-advantaged retirement account must be handled.

When a beneficiary other than a spouse inherits an IRA or other qualified retirement account, they are typically subject to the 10-year distribution rule: the funds in the account must be fully withdrawn within ten years of the date of death. However, the specifics depend on the deceased owner’s required beginning date (RBD) for taking required minimum distributions (RMDs). Under the 2020 SECURE Act, owners of traditional retirement accounts must begin taking RMDs by age 73 (72 for those born before 1951, 70 ½ for those born before 1949). If the owner was under 59 ½ upon their passing, the non-spousal beneficiary must withdraw all the funds by the end of the 10th year. The withdrawals may be made as one or more lump sums or as regular annual amounts. If, on the other hand, the owner had reached their RBD by the time of their passing, the non-spousal beneficiary must take withdrawals for the first nine years, calculated on the beneficiary’s life expectancy. In the 10th year, all remaining funds must be withdrawn.

The tax status of the earnings portion of retirement account withdrawals generally depends on the character of the inherited account. If it was a traditional (pre-tax) account, the withdrawal of earnings will be taxed as ordinary income. If it was a Roth account, they will usually be non-taxable, as long as the Roth account was in force for at least five years before the date of inheritance. In either case, no early withdrawal penalty will apply, regardless of the age of the beneficiary.

At Glassy Mountain Advisors, we know that “sudden wealth” can solve problems but also create stress at the same time. As fiduciary financial and wealth advisors, we place our clients’ best interests ahead of everything else. If you are facing the prospect of inheritance management or any other important financial situation, we are here to answer your questions.

How can I protect my wealth during a major life transition?

Glassy Mountain Advisors, Inc. is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Glassy Mountain Advisors including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request.