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Inheritance / Settlement Planning

 

 

The best thing to do with a large inheritance depends on what kind of financial planning you've already done, whether or not your inheritance is in a trust and if the money you've inherited is currently invested in tax-advantaged accounts, such as an IRA or in a taxable account.

 

Understanding What You've Inherited

 

Are you inheriting a trust? IRAs? Cash? Your financial options differ for each of them.

 

For instance, if your inheritance is in the form of a trust, your windfall will often be managed by a trustee that isn't you.

 

While trustees can be anyone, they're usually an investment advisor, banker, lawyer, or another family member. Trust beneficiaries (like you) usually aren't selected as sole trustees to avoid IRS scrutiny and, potentially, estate taxes.

 

The trustee is responsible for managing and distributing the assets held in the trust according to the trust's language, so you should carefully read the trust so that you understand the trustee's responsibilities. Also, don't forget to provide the trustee with your contact information so that you can receive regular updates on the trust's investments and performance.

 

If you aren't inheriting assets held in a trust, but they're in tax-advantaged accounts, such as IRAs or 401(k) plans, your options depend on if you're a spouse or not.

 

If you're a spouse and you inherit these accounts, you can transfer them into your name and treat them as your own or take a lump-sum payout. Often, transferring them is your best bet because traditional IRAs and 401(k) plan contributions are usually made with pre-tax money and therefore withdrawals are subject to income taxes. Also, the longer assets stay in these accounts, the more they benefit from tax-advantaged growth.

 

If you're the account holder's spouse and you inherit a Roth IRA or Roth 401(k), you have the same options. However, Roth contributions are made with after-tax money, so withdrawals from them won't be subject to income tax, as long as the account's been open at least five years. If it's been open less than five years, then any gains that are withdrawn will be subject to income tax.

 

If you're not the spouse of the account holder and you inherit an IRA, your options are limited because the IRS forces you to withdraw the money that's held in these accounts.

 

You have three options for withdrawing money in these accounts:

 

  1. Withdraw it over your lifetime
  2. Withdraw it within five calendar years following the year in which the account owner died
  3. Withdraw it as a lump sum

 

If it's a Roth account that's been open at least five years, you won't get taxed on your withdrawals, but I still like the idea of withdrawing the money over your life expectancy. Doing so will still give you at least some benefits from tax-advantaged growth and legacy planning.

 

In any case, make sure you update your beneficiaries if you transfer these accounts into your name. If you end up withdrawing all the money at once and you have to invest a lump sum or you inherited cash, pay particular attention to this next bit of advice.

 

How to invest your inheritance

 

Regardless of whether you hire an investment advisor or go it alone, it's important to know that you have a lot of investment options, and those options all come with their own share of things to consider and risks to understand.

 

One more thing to keep in mind

 

It's common for a big windfall to come with a lot of requests from family and friends, and it's important to keep these requests in the proper perspective. Sometimes, helping out a family member or friend financially can cause friction that ends up ruining that relationship. To reduce the risk of that happening to you, don't be afraid to lean on your advisor as a go-between. They can help you figure out what requests make sense and what don't.