It’s not unusual for people to think of an inheritance as a sort of safety net. If times get tough, there’s always a chance that a rich uncle or generous grandparent will swoop in and solve all their financial problems. But is relying on an inheritance really the best way to plan for your financial future?
According to Experian, “The average inheritance is $46,200, according to the Federal Reserve. While $46,200 would be a welcome addition to anyone’s retirement fund, it probably wouldn’t generate a comfortable retirement all on its own, especially if you receive it later in life. Moreover, plenty of variables can stand between you and an expected inheritance. Even if you’re anticipating an inheritance, you shouldn’t rely on it solely in your retirement planning.”
Here’s why you might not want to count that money before it hits your bank account.
1. You can’t guarantee an inheritance
Relying on an inheritance is ultimately like planning to win the lottery. Just because your parents or grandparents are wealthy now doesn’t necessarily mean they’ll hand down the same amount of money to you. Many things can come up including end of life care that could easily drain a bank account.
In fact, many people end up leaving more money to charity than their children, or their funds may dwindle due to unforeseen expenses and costs. This leaves their children with little to nothing to inherit.
It can also lead to laziness and poor financial decisions. When you have the mindset that an inheritance is going to bail you out, it’s tempting to put off making smart financial choices. You might decide to take on more debt, not start a retirement fund or pass up opportunities to save money. The problem is that these decisions can leave you in a much more precarious financial position if the inheritance doesn’t come through when you need it most.
2. Inheritances can take years to go through probate
Planning your finances in the hopes of an inheritance also ignores the fact that the probate process can be lengthy and unpredictable. In general, probate has to take place before assets can be distributed to heirs. This process can take several years in some cases and eat away at the value of the estate, meaning that the reality of what you might receive can differ significantly from what you’ve planned for. During this time, you’ll also need to maintain your own financial stability, which may be difficult if you have waited until now to finally budget properly.
3. Inheritances may come with strings attached
Even if your inheritance is free of complicated probate issues, you never know if there will be strings attached to the money. Estate planning lawyers often warn their clients about the dangers of leaving liquid cash to loved ones who may not have the experience or knowledge to manage the funds. Some parents or relatives may choose to structure their inheritance as a trust with specific terms for how the money can be spent or with certain milestones that a beneficiary must achieve to earn the payout.
4. You may face unexpected tax consequences
One area where many financial planning clients get caught up when factoring an inheritance into their plans involves taxes. For example, if you suddenly inherit a big lump sum of cash, you may face significant tax consequences for the year in which you receive it.
Additionally, if any part of the inheritance involves shares of stock or real estate, you may also be liable for capital gains taxes if Congress changes the law, which currently allows for a step-up in tax basis. Or, even if the law remains unchanged, you may find the assets are held in a way that doesn’t allow for a step-up in basis (for example, something called NUA stock). In some cases, the taxes you would owe could wipe out a significant portion of the inheritance right away, leaving you struggling to regain your financial footing.
Focus on proactive planning and budgeting instead of the inheritance
The bottom line is that relying solely on an inheritance is not a sound or reliable financial strategy. A better plan is to focus your energy on proactive budgeting and investing, as well as creating a comprehensive financial plan that doesn’t rely on a “lucky break” or sudden inheritance.
Working toward your goals with a financial advisor has two big benefits:
- You’ll know where you stand whether you receive an inheritance or not.
- If you DO receive an inheritance, you already have a trusted resource to help you with everything that comes with it.
Also, while it’s not wise to depend on a possible inheritance, it can be beneficial to encourage relatives to create or update their estate planning documents. We know that conversations around assets can be awkward but knowing that everything is in place could also make your loved ones feel more secure; they’ll know their wishes will be fulfilled.
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