Inheritance Planning Strategies for Advisers and Clients

Financial advisers can help their clients manage both the expectations and the reality of an inheritance
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Cerulli Associates estimates that a $68 trillion intergenerational wealth transfer will take place over the next 25 years. For financial advisers, many of clients may be the beneficiaries of an inheritance in the coming years, and it’s important to help them factor an inheritance into their financial planning.

Expectations vs. Reality

Clients may sometimes have an expectation that they will be receiving an inheritance from their parents or another relative upon that person’s death. Depending upon how well you know your client and their family situation, you may or may not be in a position to determine how realistic their expectations of receiving an inheritance are. This also goes for the size of the inheritance.

It’s generally a good idea to not count on an inheritance that hasn’t happened yet. In some cases, a client may not be as committed to good financial planning habits if they are expecting to be bailed out by an inheritance.

Sometimes things change. Your client could have a falling out with the relative from whom they are expecting the inheritance. Or that relative could experience a major financial setback, reducing or eliminating the inheritance.

It's important to ensure that your clients continue to save, plan and invest as if the expected inheritance will not materialize. That way they won’t come up short of their goals if things don’t work out as expected.

What the Inheritance Is Received

According to data from the Federal Reserve, about one-half of all inheritances amount to $50,000 or less. About 30% are in the range of $50,000 to $250,000. About 2% of all inheritances are in excess of $1 million.

Regardless of the size of the inheritance, counseling your client to step back and take a breath before deciding what to do with this windfall is sound advice.

There are a number of factors to consider for after they receive the inheritance. One is the size of the inheritance. If it is a relatively small amount compared to the client’s overall net worth, you might suggest they make a major purchase that they have been putting off, pay off a debt or perhaps donate some of it to charity. Investing some of it and adding a portion to their emergency fund are also, of course, solid uses for this money.

Assuming the amount is more significant, you will want to work with your client to discuss their goals and their priorities for the money. Most of all, you will want to help them work through a plan for the money. This will include some or all of the money into their current financial planning. This might involve incorporating the money into their investment portfolio, designating some of it to fund their children’s education or funding other financial goals.

While it makes sense for your client to set aside a portion of the inheritance to enjoy, people react differently to sudden wealth. It’s fine for the client to go out and buy that sports car they’ve always dreamed of, but they may need your help in staying grounded and utilizing the money to help achieve their longer-term personal and family financial goals.

As with all of the planning you do for your clients, this is a situation where you should be working through alternatives for the money to help your clients stay focused on their long-term goals.

Understand the Details

Sometimes an inheritance is received as cash, as is the case for the beneficiary of a life insurance policy. Other times, the assets received may be shares of stock, a retirement account, real estate or an interest in a business. These and other types of assets may need to be sold in some cases unless your client wants to retain the assets in their current format.

In some cases, assets received may benefit from a step-up in basis at death. Examples can be securities like individual stocks, ETFs, mutual funds and others. This can also be the case with some types of real estate as well. Depending upon your client’s situation, it may make sense to sell some of these assets soon after they are inherited to avoid capital gains taxes and to reallocate the assets into other holdings more in line with their overall portfolio.

Sometimes the assets received are more complex, such as an interest in a private business or artwork and collectibles. In some cases there may be stipulations attached to the inheritance. In these cases your client will need your guidance and perhaps the guidance of an attorney to determine how to realize the maximum value from these assets.

Taxes

With the current levels for the estate tax exemption at the federal level, $11.7 million for 2021, it is rare to have federal inheritance taxes to deal with. However there could be inheritance taxes at the state level for your client.

Where taxes can come into play is with an inherited IRA if your client inherits the account from someone other than their spouse. With the changes in the rules for inherited IRAs for non-spousal beneficiaries under the SECURE Act, your client may be forced to withdraw the entire amount of the inheritance within ten years of receiving it. They will need your help in looking at planning alternatives to preserve as much of this amount as possible, especially if they are already in a high tax-bracket on their own.

Receiving an inheritance is a good thing for your clients. They will rely on your guidance and sound advice to help them incorporate this money into their financial plan and to make the most of this windfall.