4 Important Financial Considerations When Inheriting Money

When a parent or other loved one passes away and leaves you with an inheritance, the money—and the tax treatment of it—is likely not the first thing on your mind. But as you move forward, it's important to understand that there are financial considerations when inheriting money.

Will Creech, Wealth Planning Strategist at First Citizens Bank, offers these planning and preparation tips to hopefully make the process easier as you decide what to do with an inheritance.

1 Learn your parents' estate wishes

While it may be a difficult conversation to have, it's worth talking to your parents as soon as possible about what's in their overall estate plan, including any planned inheritances. Ask them to share all estate planning documents, including medical directives like a living will, healthcare power of attorney and financial power of attorney. Creech says parents should review and update these documents—along with their will and trust documents—at least every few years.

"After updating these documents, we recommend parents set up a family meeting with their children so they can talk about their wishes and their estate plan," Creech says. "We encourage these meetings to be held with the parents' financial planner so the planner can answer any questions."

According to Ameriprise Financial's 2022 Money & Family study, only 19% of people said they were completely transparent with family when discussing their estate planning, even though 67% say passing generational wealth to heirs is important to them.

2 Consider potential estate taxes

If it meets a certain threshold of assets, your parents' estate will have to pay federal estate taxes when they die. In 2022, 12 states and the District of Columbia also had their own estate taxes. For 2022, the federal estate tax exemption is $12.06 million for an individual and $24.12 million for a couple over a lifetime. Most of any estate value above these exemptions is taxed at 40%. The exemption amounts are adjusted each year for inflation.

However, on January 1, 2026, the exemption is scheduled under current law to drop by half, or to about $6 million in today's dollars. These limits are subject to legislative change and have been updated more than once over the past few decades, so check with your tax and estate professionals to make sure you know the current status.

Your parents can reduce their estate tax by gifting you or anyone else—including a charity—up to $16,000 per person per year without the recipient having to pay a tax on the gift, as long as it doesn't come from a foreign source.

3 Understand how different assets are treated

For some, an inheritance may be more complicated than simply being handed a stack of money. And different types of assets may have different tax implications, depending on what you do upon receiving them.

Cash

If you receive cash through a parent's will, you typically won't owe any income taxes on inheritance money.

Stocks, bonds, businesses and real estate

You also don't pay income tax on inherited securities like publicly traded stocks and bonds or on any interests in private businesses, limited liability companies or corporations—until you sell them. For inherited securities and real estate, there's an added tax benefit of receiving a step up in tax basis—meaning both are updated to the fair market value upon your parent's death date or 6 months after that date.

For example, if your parent bought $10,000 worth of stock and it appreciated to $30,000 by the time they died, you won't pay capital gains taxes on the increase in value if you sell the stock when you inherited it because its basis value resets to the market price on the date of death. If you hold onto the stock and sell it at a later date, you only pay taxes on how much it has appreciated from its $30,000 value on the day you inherited it.

The same rules apply if you inherit property. If you use it as your personal residence for at least 2 out of the 5 years before selling it, you may be able to deduct an additional $250,000—or $500,000 for a couple—from the sale price on your taxes. If you use it as a rental property, all rental income is taxable but you may be able to deduct expenses and the house's depreciation from your taxes. Talk to a tax professional or financial advisor for more details on your specific situation.

Retirement accounts

Under the 2019 SECURE Act, non-spouse beneficiaries who inherit a 401(k), traditional IRA or Roth IRA have only 10 years to withdraw all funds from the account, assuming the person who left you the account was already at the age where they were required to take required minimum distributions. For 2022, that age is 72. For 2023, it's 73.

As the inheritor of one of these accounts, you also have the option of taking the money out in a lump sum anytime during the 10-year span, but you'll pay income taxes on the taxable part of the distribution. Make sure this sudden increase in funds doesn't bump you into a higher tax category.

Insurance policies and annuities

No income taxes are owed on inherited life insurance policies if you elect to take the proceeds as a lump sum. If you choose to take payments in installments, the interest that accrues on the balance of the account is taxable.

No tax is due on money inherited through an annuity that provides a death benefit. Payments you may receive through an annuity with a survivorship right—which means you inherit the right to receive the annuity's regular payments—are subject to income tax. Both the death benefit and survivorship right benefits are set up when the annuity is purchased.

4 Review any unique trust-related scenarios

When you inherit an asset from your parents through a trust, many variables can be at play because trusts allow for a lot of flexibility.

"A trust gives parents a way to assert more control over what they want to accomplish with their estate," Creech says. "If there's a family beach house they own, they can set stipulations on how long it must remain in the family before it's sold. Or if there's a younger child who hasn't gone to college yet, they can establish a trust to ensure that child has the funds to get a college education."

If it's an irrevocable trust, the trust will pay taxes on the assets before they pass on to you. Additionally, assets in a trust don't receive a step up to the current fair market value.

While you typically don't have to pay an inheritance tax, it's important to note that in 2022 six states had inheritance taxes that may apply to the value of a single bequest made to beneficiaries.

Special considerations for caregiving children

If you were one of the 47 million Americans caring for an aging parent before they died, there may be other financial considerations. If your parent added you to their bank account so you could manage their day-to-day finances and the account was set up with a right of survivorship agreement, the money in that account goes to you—even if your parent designated in their will that they want the money in that account to be split evenly among all their surviving children, Creech notes.

"To avoid this scenario, the parent and child should take a financial power of attorney document to their financial institution," he says. "This allows the child to be added to the account so they can assist with money management, but when the parent dies the assets will follow their estate plan and won't inadvertently pass solely to a child caretaker who was added as a joint owner."

Unpaid US family caregivers spent an annual average of $7,242 of their own money taking care of an aging parent (PDF). If you're in this scenario, you may want to repay yourself with some or all of your inheritance.

Because each individual situation is unique, consider this information when talking to your financial advisor and estate and tax professionals about what to do with your inheritance.

"I first recommend having an emergency fund that meets your financial needs for 6 to 12 months comfortably," Creech says. "Second, look at your cash flow. If there's debt that impacts your monthly budget that isn't your mortgage, look at eliminating it to increase your surplus. Then look at how your retirement savings are doing."

Creech also urges clients to make sure their savings for retirement are on track before prioritizing education spending.

"You can borrow for education, but you can't borrow for retirement," he says.