If you are the fortunate recipient of an inheritance, be it small or large, from someone else’s estate, it is prudent to pause to evaluate the consequences.
In the past, inheritances often came with tax consequences. Fortunately, this is not a problem for most Californians who inherit money or assets from other’s estates.
The two most common tax issues related to inheritances are the estate tax, sometimes referred to as the “death tax” and the inheritance tax.
The estate tax is the federal tax paid upon one’s death if the size of the estate exceeds a certain level. California does not have a separate estate tax. Remember, this tax is paid by the deceased person’s estate, not the recipient of the inheritance. Even before the most recent tax law change that level was in excess of $5 million. The newest law increased the level to over $11 million.
The inheritance tax is the tax paid by someone who inherits from someone else’s estate. Again, good news for Californians is that California does not impose an inheritance tax upon its residents who inherit property. This is not true for some states in the eastern U.S.
Certain inheritances do carry a tax burden. These are the tax-deferred accounts, such as IRAs and certain annuities, where the deceased person had not withdrawn all the money before his or her death. The designated beneficiaries of these accounts must assume the responsibility of these taxes but there may be options on how to defer those taxes. You should consult with a competent tax advisor BEFORE accepting these inheritances.
A very common reaction to learning of a windfall, particularly one that is unexpected, is that it is free money and the immediate impulse is to find ways to spend it.
While it may be a good idea to use the funds to buy something needed, such as a car when your current car is old and unreliable, overspending on a new car because you got a pile of cash can be a big mistake. Many purchases such as new vehicles and homes carry with them ongoing costs such as upkeep, repairs, insurance and even taxes. If you spend all your money on the purchase, there may not be sufficient funds to pay these ongoing costs.
Improving Your Future
As most workers know, saving for one’s retirement these days is a complex but critical need. Social Security will not provide sufficient funds for a comfortable retirement and long gone for most workers is the monthly pension check paid by your employer. Most workers need to save for their own retirements in company-based plans, such as 401k’s, or by private planning, e.g. IRAs.
Of course, you should also have a “rainy day” fund, i.e., a cash reserve to cover unexpected expenses, such as a major repair or illness or a job loss.
Consulting with competent legal, tax and financial advisors will greatly enhance the chances that your inheritance will be put to best use in both the short and long run.