Receiving an inheritance can be a mixed blessing. Along with welcome financial gain come responsibilities that if not properly handled can give rise to many unanticipated problems. Here are some mistakes and how to avoid them.
1. Not Considering Potential Taxes
You do NOT pay income tax on an inheritance. Instead, there are death taxes, both State and, in some cases, Federal. Pennsylvania imposes an inheritance tax on anyone, no matter where they live, who inherits assets from a deceased person who lived in Pennsylvania. The tax is levied at a flat rate that depends upon the relationship of the person inheriting to the person who died. Spouses pay zero %. Descendants (children, grandchildren, etc.) and ancestors (parents, grandparents, etc.) pay 4.5%; siblings pay 12%; and with some limited exceptions, everyone else pays 15%. The Federal Estate Tax applies only to the very wealthy; but it kicks in at a whopping 40%! Fortunately, most of the expenses involved in administering and distributing a decedent estate qualify as deductions against Pennsylvania and Federal death taxes.
Also be aware, that as regards income taxes, although inherited assets are not taxable income, the income generated from an inheritance from date of death until distribution and termination of the decedent’s estate DOES incur State and Federal income tax. In most cases, that amount of income will not be significant. But, depending upon the nature and amount of the inheritance, the income tax hit, which comes in addition to death taxes, can be substantial.
Dionysios Pappas, an attorney with the law firm of Vasiliadis Pappas Associates notes that “with the assistance of an experienced estate planning attorney, you can, in many cases, significantly, if not completely eliminate death taxes and income taxes generated by a decedent estate”. But in order to do so, the timing of income receipt and of deductible expenses can be crucial.
2. Spending Too Much
When receiving a large sum of money, you may assume that it will easily last. All too often, people fritter away inheritances by making major purchases right away, such as cars, boats, or vacations. Even if such purchases don’t seem all that significant at first, the costs can accrue quickly, especially if items you’ve purchased have additional costs, such as maintenance and insurance.
Stay grounded and take time to consider whether you truly need what you’re buying. Also, think through how much more money you could have in the future if you invest the money instead of spending it now.
If you don’t already have a budget, create one. This will help you avoid overspending and rapidly depleting your inheritance. With a budget, you can factor in your new funds and it will help you see how the inheritance will affect your saving and spending strategy.
3. Not Paying Off Debts
Paying off debts should be your first priority if you inherit a large sum of money. Paying off your mortgage, credit cards, or student loans will give you more freedom to do other things. You will still need to balance the debts you decide to pay with the amount of money you’d like to invest for the future.
4. Losing Other Income Sources
For people relying on needs-based public or private benefits, such as Supplemental Security Income (SSI), Veterans’ Aid & Attendance, or Medicaid, all of which have strict asset and income limits, receiving an inheritance could end up disqualifying them from these crucial programs. An elder law attorney experienced in representing elderly and incapacitated persons of all ages can help protect an inheritance while retaining benefits eligibility for the recipient. Measures might include the use of a Special Needs Trust. Such a measure is particularly important to include in an estate plan for parents who have a special needs child.
5. Not Getting Expert Advice
An inheritance, especially a sizeable one, can help you achieve financial security and allow you to pursue a dream career or some other life goal. However, an inheritance can vanish surprisingly quickly if not managed well. Before doing anything with your inheritance, consult with a financial advisor, accountant, and an estate planning attorney. The attorneys at Vasiliadis Pappas Associates have assisted many clients in protecting inheritances. Call us. We can help!
