Americans who are over the age of 55, mainly baby boomers, own more than half of the country’s wealth. Over the next two decades, it will be passed down to the generations that follow, marking the greatest wealth transfer in our country’s history.
While many of us look at inheritance as something purely for the wealthy, 66% of Americans either expect to or have already received an inheritance from their parents, according to a survey from Choice Mutual.
Receiving any kind of inheritance can be overwhelming, and being unprepared can lead to losing much of that money to poor financial decisions or taxes. If you think you may be a part of the Great Wealth Transfer, either as a provider or a beneficiary, here’s how to avoid those pitfalls.
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1. Start conversations now
One of the biggest issues with the trillions of dollars expected to be passed down during the Great Wealth Transfer isn’t the money itself, but beneficiaries being unprepared to manage the assets they receive.
Although it may be uncomfortable, discussing the plan for these ahead of time helps family members know exactly how much they will receive and what taxes they might expect.
If beneficiaries don’t have a chance to discuss the inheritance before their loved one passes away, they may end up making important decisions while they’re grieving.
Bringing the topic up well beforehand will give them time to plan before their emotions take over, helping reduce the likelihood of poor decisions or impulsive spending.
Some of the most successful inheritances I have seen are among families who prioritize these conversations.
2. Avoid spending sprees
If you suddenly receive a windfall, it can be tempting to spend money on the things you’ve always dreamed of. You may want to buy a bigger house, a more expensive car or finally take that extravagant vacation. But going on a shopping spree can lead to disaster.
Your dream items will come with additional costs, such as taxes, insurance and maintenance, and those will stick around long after the initial purchase.
You should look at your inheritance as a long-term investment, not an excuse for a one-time splurge. If you have a good plan for the assets, they should help provide financial security for years.
Using the money to pay down any debts you have or starting an emergency fund is much more valuable than spending it on an asset that will eventually lose its value.
3. Consider tax implications
While the tax implications that come with an inheritance will depend on what you inherit and where you live, receiving an inheritance can trigger estate, capital gains, inheritance or income taxes.
For example, while many people may believe they will owe federal income taxes on any inherited money they receive, that may not be the case. Cash that is passed down from a person who has passed away is not considered taxable income for the beneficiary.
If you are gifted a property as an inheritance, receiving it is not taxed in most cases. However, depending on how you plan to use it, you need to consider a few things:
- Ongoing property taxes, insurance and maintenance costs
- Capital gains tax if the property value increases significantly before it is sold
- How you will use the property (personal, investment, rental) determines which tax deductions you can take
Most people don’t have a full understanding of which processes will be triggered when estates are handed down. It’s important to work with a financial professional before signing anything.
4. Build a strong team
Being part of the Great Wealth Transfer may be life-changing, but it could also be overwhelming. You may be faced with financial decisions you’ve never had to navigate before.
Having a strong team of professionals, such as a trusted financial adviser, tax professional or estate attorney, can help everyone involved avoid costly mistakes and create strategies that align with their goals.
A large inheritance is a life-changing event, and surrounding yourself with the right people can be the difference between enjoying it and watching it disappear.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
