An inheritance may be coming soon

[Badger]

My wife's mother is not doing well (92 yrs) and is getting hospice care at a memory care facility. It may not be too long before she calls it a day.

Wife's brother has POA and is sometimes difficult to work with. I could use a refresher regarding inheritance. It will involve a large sum of money mainly invested in stocks and mutual funds for both wife and brother.

What are the tax considerations? If everything is converted to cash and distributed to the two children would the entire amount be free of taxes? What other concerns should be considered for the distribution?

I seem to recall when my folks passed away and the investments were distributed there were no taxes but the amounts were about $350k. This time it may be 3X that for my wife. Any thoughts or suggestions?

Cheers!

 

[Another Reader]

Power of attorney is only valid while she is alive. After she dies, the executor of the estate takes over.

In most cases, the assets are stepped up in basis at death. The executor will probate the will if there is no living trust and distribute the assets after all bills are paid. The will and the trust may dictate how the assets are distributed. If she has no real estate or other hard assets that must be sold before distribution, the process is fairly simple.

ETA: No federal estate tax is due at this asset level. There may be a state inheritance tax, depending on MIL's state of residence.

 

[Newventurer]

Note to your wife: she wants to make sure that she doesn’t commingle these inherited funds with other jointly held assets in the event she desires to leave you for the Bahamas with her stash and 20 something yo boyfriend and doesn’t plan to share her new wealth

 

[Badger]

Note to your wife: she wants to make sure that she doesn’t commingle these inherited funds with other jointly held assets in the event she desires to leave you for the Bahamas with her stash and 20 something yo boyfriend and doesn’t plan to share her new wealth

I thought of that and already fired the cabana boy.

Cheers!

 

[Mykle57]

In the situation the 'invested funds' are at a brokerage, wouldn't these funds be distributed directly to the brokerages beneficiary on record? Regardless of what is in the will. Same for insurance policy payouts. Right?

If there's a trust involved then that's a different matter.

 

[Another Reader]

IRA's should be distributed to the beneficiaries of record by the custodian.

 

[athena53]

IRA's should be distributed to the beneficiaries of record by the custodian.

Note also that there's no reason to liquidate them. Most of the time they can be moved to an account in the new beneficiary's name without selling anything. Same for after-tax accounts.

If an IRA is inherited, the beneficiary must withdraw it over a 5-year period. Doesn't mean it has to be spent- just has to be put into an after-tax account with taxes (but no penalties) paid. One exception is an IRA inherited from a spouse, which does not have to be withdrawn over 5 years, but I assume that's not the case here. I just remembered another thing: if she doesn't take this year's RMD before she dies, I'm pretty sure it will still have to be paid after she dies.

Caveat: I'm not a tax expert, but this is what I learned when DH and I looked into making his son (DSS) the beneficiary of his IRA. We discussed it with DSS and it turned out he was interested in liquidating it immediately, with bad tax consequences since he's only in his 40s. We ended up making me the beneficiary and after DH died I wrote a check to DSS from my after-tax accounts for the value of the IRA. DH's will left everything to me, so I had the flexibility to do what worked best for everyone.

 

[SheitlQueen]

What are the tax considerations? If everything is converted to cash and distributed to the two children would the entire amount be free of taxes? What other concerns should be considered for the distribution?

Cheers!

I just went through this. The estate paid all the taxes that were due and then the executors were left with several decisions: sell everything and distribute cash which left the inheritors to pay the capital gains, or just divide up the stocks/funds and distribute without selling, which would have avoided capital gains but which would stick us with a bunch of stocks and funds we necessarily didn't want and would sell anyway, or divide things up and take the capital gains money out of the estate, which would have been at a much higher tax rate. We opted for the first route.

You may or may not have taxes. There may be federal or state inheritance taxes, depending on the amount of the estate and where your live.The estate paid those. If there were capital gains, you will owe taxes on those. If the state was settled quickly, those should be small. Unfortunately it took eleven months for our estate to be settled and distributed, and since there was a huge run up in the stock market, we all got hit with capital gains which means I lost my ACA subsidy and I will have to pay taxes this year. Of course the good thing is the run up means we made more money, even after paying the taxes.

 

[Another Reader]

Note also that there's no reason to liquidate them. Most of the time they can be moved to an account in the new beneficiary's name without selling anything. Same for after-tax accounts.

If an IRA is inherited, the beneficiary must withdraw it over a 5-year period. Doesn't mean it has to be spent- just has to be put into an after-tax account with taxes (but no penalties) paid. One exception is an IRA inherited from a spouse, which does not have to be withdrawn over 5 years, but I assume that's not the case here. I just remembered another thing: if she doesn't take this year's RMD before she dies, I'm pretty sure it will still have to be paid after she dies.

Caveat: I'm not a tax expert, but this is what I learned when DH and I looked into making his son (DSS) the beneficiary of his IRA. We discussed it with DSS and it turned out he was interested in liquidating it immediately, with bad tax consequences since he's only in his 40s. We ended up making me the beneficiary and after DH died I wrote a check to DSS from my after-tax accounts for the value of the IRA. DH's will left everything to me, so I had the flexibility to do what worked best for everyone.

Unless the rules have changed, a non-spouse beneficiary should be able to stretch the IRA over the life table created by the IRA for this purpose.

 

[ERD50]

I just went through this. The estate paid all the taxes that were due and then the executors were left with several decisions: sell everything and distribute cash which left the inheritors to pay the capital gains, or just divide up the stocks/funds and distribute without selling, which would have avoided capital gains but which would stick us with a bunch of stocks and funds we necessarily didn't want and would sell anyway, or divide things up and take the capital gains money out of the estate, which would have been at a much higher tax rate. We opted for the first route. ...

? I'm not following this.

Gains are stepped up at the date of death, so cap gains should be minimal, if not zero. If some time has gone buy since DOD, then there may be some larger cap gains involved.

But you can't "avoid" those gains, can you? I suppose if they are sold by the estate and then the cash is distributed, the taxes are paid from the estate. If the stocks are transferred (not sold by the estate), then I think the beneficiaries will pay cap gains when they sell them (using the cost basis set at the DOD of the estate owner).

-ERD50

 

[athena53]

Unless the rules have changed, a non-spouse beneficiary should be able to stretch the IRA over the life table created by the IRA for this purpose.

Thanks- I just checked that. I found references to both a 5-year option and a lifetime option for non-spouse beneficiaries.

 

[OldShooter]

... Wife's brother has POA and is sometimes difficult to work with. ... It will involve a large sum of money ...

Rather than consulting SGOTI, I suggest that you buy an hour with a good trusts & estates attorney. You can get your tax questions answered but, more importantly, you'll have someone up to speed and available to consult with as the executor (BIL?) proceeds with the estate. The executor doesn't even need to know that you are consulting unless things start to go off the tracks. Which can happen. For example, will the executor be paid? How much? Is this stipulated in the will or can the executor just decide? What about timing? What if the executor unreasonably delays closing the estate, leaving you with possibly unwanted market risk? There are lots more what-ifs that may cause you to need professional advice. Better to be prepared.

 

[kgtest]

Thanks- I just checked that. I found references to both a 5-year option and a lifetime option for non-spouse beneficiaries.

One thing to note, if one account is distributed to three non-spousal beneficiaries, the IRS uses the life expectancy of the oldest beneficiary.

To avoid paying an accelerated RMD schedule for the younger beneficiaries, I would advise account owner to create IRA accounts separate, and name each benefactor separate, to allow for separate inherited RMD schedules.

I am not a trust expert though.

 

[SheitlQueen]

? I'm not following this.

Gains are stepped up at the date of death, so cap gains should be minimal, if not zero. If some time has gone buy since DOD, then there may be some larger cap gains involved.

But you can't "avoid" those gains, can you? I suppose if they are sold by the estate and then the cash is distributed, the taxes are paid from the estate. If the stocks are transferred (not sold by the estate), then I think the beneficiaries will pay cap gains when they sell them (using the cost basis set at the DOD of the estate owner).

-ERD50

Yes, they are stepped up but in our case it took 11 months for things to be sold and distributed and there are $355,000 in capital gains, split between five of us who inherited.
We did not have the estate pay the capital gains taxes, it would have been nearly 40%. It was much cheaper to have everything sold, cash distributed, and they we each paid our own capital gains tax. If things were not sold, we would have paid capital gains when we sold them. However, it would have been difficult to divide everything evenly, and most of us would have sold in the long run to invest the money in what we wanted. The estate was invested through Edward Jones, needless to say their choices of how the money was invested was not one most of us agreed with.

 

[ERD50]

Yes, they are stepped up but in our case it took 11 months for things to be sold and distributed and there are $355,000 in capital gains, split between five of us who inherited.
We did not have the estate pay the capital gains taxes, it would have been nearly 40%. It was much cheaper to have everything sold, cash distributed, and they we each paid our own capital gains tax. If things were not sold, we would have paid capital gains when we sold them. However, it would have been difficult to divide everything evenly, and most of us would have sold in the long run to invest the money in what we wanted. The estate was invested through Edward Jones, needless to say their choices of how the money was invested was not one most of us agreed with.

It's confusing the way you put it (but that's a nice gain in 11 months!). They were sold by the estate, or not sold?

I think you mean that the stocks were sold by the estate, and the gains distributed to the beneficiaries through a K-1 that same tax year, along with the cash? Is that it?

As I understand it, with gains distributed through a K-1 to an individual, the individuals will be responsible for that K-1 income at their personal tax rates. It is only the gains retained by the estate that are taxed at estate rates.

-ERD50

 

[harley]

Caveat: I'm not a tax expert, but this is what I learned when DH and I looked into making his son (DSS) the beneficiary of his IRA. We discussed it with DSS and it turned out he was interested in liquidating it immediately, with bad tax consequences since he's only in his 40s. We ended up making me the beneficiary and after DH died I wrote a check to DSS from my after-tax accounts for the value of the IRA. DH's will left everything to me, so I had the flexibility to do what worked best for everyone.

Unless this was a pretty small IRA, wouldn't writing a check create a gift tax issue?

 

[Badger]

I just received the monthly statement of account as summarized by BB&T financial advisors for her investments. There is no indication in the paperwork that she has an IRA. I don't believe she ever worked in the past 30+ years to have one. I think all of her investments are in taxable accounts. It just indicates the value of the accounts as in equities.

It also indicates she has a revocable trust so does that mean this could possibly be distributed without a waiting period as you might for just a will? I'm thinking this might be an easy sale of equities and an easy distribution to the 2 children. There would be very little in debt other than the financial advisor bill. Each child should receive about $1M. Would there be any tax concerns for this size inheritance or would it be free and clear of taxes under these conditions?

Cheers!

 

[SheitlQueen]

It's confusing the way you put it (but that's a nice gain in 11 months!). They were sold by the estate, or not sold?

I think you mean that the stocks were sold by the estate, and the gains distributed to the beneficiaries through a K-1 that same tax year, along with the cash? Is that it?

As I understand it, with gains distributed through a K-1 to an individual, the individuals will be responsible for that K-1 income at their personal tax rates. It is only the gains retained by the estate that are taxed at estate rates.

-ERD50

Yep, large estate and a good year for stocks
Correct. Accountant said we had the option of the estate paying the capital gain taxes (at almost 40%!) or we could pay them ourselves. Of course we opted to pay them ourselves.

 

[Andre1969]

Thanks- I just checked that. I found references to both a 5-year option and a lifetime option for non-spouse beneficiaries.

Actually, if you're a "direct line" descendant (I think that's what it's called...parent, grandparent, child, grandchild), then you can opt for the longer option on an inherited IRA. I did this when my Grandmom passed away in 2015, and when Dad passed away early last year.

It's also not quite lifetime, although it's a pretty long withdrawal period. Even though I was 45 when I opened the first, and 47 when I opened the second inherited IRA, they both appear to be designed to deplete completely when I'm 84. The RMD is something like 3.7% the first year, but then ramps up, depending on your age, but no matter how much it might make, it still zeroes out at age 84.

 

[AginMS]

Accountant said we had the option of the estate paying the capital gain taxes (at almost 40%!) or we could pay them ourselves. Of course we opted to pay them ourselves.

I’m confused why the capital gains rate on $355K be more than 15% (up to $470,700) or at the very most 20% (on $470,700+)?

Can you explain that for me?

Thanks.

 

[ERD50]

I’m confused why the capital gains rate on $355K be more than 15% (up to $470,700) or at the very most 20% (on $470,700+)?

Can you explain that for me?

Thanks.

If the gains are retained in the trust, they are taxed at estate & trust rates, and short term gains are taxed at the income rate.

Income is taxed at 39.6% Over $12,500 on Trusts. And retained LTCG are taxed at 20% at that level. That can be a big difference on a large gains.

I still find SheitlQueen's wording confusing. You don't "have the option of the estate paying the capital gain taxes or paying them ourselves". This is clearer, IMO:

If you have realized gains/income in the trust, you have the option of distributing them in the trust's tax year, or retaining them in the trust to be distributed later.

If you distribute them in the trust's tax year, the individual pays taxes on them at their personal tax rate (they should receive a K-1).

If you retain realized gains/income in the trust, the trust pays taxes on them at their trust tax rate.
​

Yes, result is the same, but the cause should be made clear - it is "retained" versus " distributed" that determines how they are taxed. You don't just "have an option" of how they are taxed - it is the result of your action (or inaction).

All the sources I find are pdf's that don't copy/paste cleanly - here's one:

https://www.edwardjones.com/images/OPR-9806A-A.pdf

-ERD50

 

[AginMS]

ERD50,

Appreciate the reply and link. I had no idea estates and trusts were taxed that way - those rates are brutal at those income/capital gain amounts.

 

[RobbieB]

Yup. My attorney advised liquidating the trust ASAP for just that reason.

 

[ERD50]

ERD50,

Appreciate the reply and link. I had no idea estates and trusts were taxed that way - those rates are brutal at those income/capital gain amounts.

Yup. My attorney advised liquidating the trust ASAP for just that reason.

Just to be super-clear, those tax rates apply only to gains that are retained by the trust. As long as they are distributed, the person who received the funds will have the gains taxed at their own personal tax rate.

Distribution of principal should not be a taxable event.

So why liquidate a trust ASAP? If it no longer serves a purpose, sure. I think the only real downside is a little extra cost in preparing the tax forms, including issuing the K-1s (these document that the gains were distributed).

That is my understanding, I could be wrong and would appreciate correction on any points - but I'm pretty confident this is how it works.

-ERD50

 

[gayl]

Sorry to hear about MIL, tough times.

When mom died it was amazingly simple: FIDO needed 15 minutes, certified death cert, open account for each sibling. She (FIDO branch mgr) split everything in 5ths except 1 got an extra penny. (TOD / POD)

House was harder, took 2 days to find a WFB that would follow intent (poorly written trust) and 2 hrs there to fix it all.

Retained her old CPA to do all necessary forms as she passed in 2012 and house was sold 2013. Best 2k ever

DB did run it passed his firm's attny but he said we didn't need anything else. 2nd best ($250)

You get what you pay for