What Role Should an Inheritance Play in Retirement Planning?

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The greatest transfer of wealth in U.S. history is expected to occur in the coming years as baby boomers pass away and Gen Xers and Millennials inherit their assets. It has been estimated that this wealth transfer could be as high as $30 trillion.

Given how ill-prepared financially many Americans are for retirement, this windfall could end up being a financial lifeline for some people who have inadequate retirement savings. There are a few things you should keep in mind if you’re counting on an inheritance as a major source of retirement income.

Look at Your Big Picture

The first thing to consider is where the inheritance fits into your overall financial picture. This will depend mainly on how large the inheritance is.

If it’s a relatively small inheritance — say, under $100,000 — this is probably not enough money to fund a long-term retirement all by itself. Sure, it will help, but you’ll probably need more money than this if you spend 20 to 30 years or longer in retirement. In this scenario, it might be smart to consider using the inheritance to pay down debt, such as high-interest credit cards or student loans, or maybe even to pay down (or pay off) your home mortgage. This could free up other funds that you can use for retirement income.

But if it’s a fairly large inheritance, such as $500,000 or more, this money could provide a major portion of your retirement nest egg if it’s managed properly. You should speak with your financial advisor about the best ways to invest an inheritance of this size, based on the number of years until you plan to retire and your level of risk tolerance.

Other Things to Consider

Other important factors to consider are how the inheritance will be paid out and what kind of assets you’ll be inheriting. For example, an inheritance could be paid outright in one lump sum, or the assets could be held in trust. If a trust is involved, make sure you know who the trustee is and if there are any requirements or stipulations that must be met before you can access the funds.

Inheriting cash is relatively simple, but things can get more complicated if an inheritance is comprised of assets like investment securities or real estate, retirement accounts, collectibles or shares in a closely held business. You will need to work closely with the trustee as these assets are liquidated and transferred into your name.

If you inherit a house, you have three options: sell the home, rent the home or live in the home. If you sell it, you can pay off the mortgage balance (assuming there is a balance) and invest the proceeds in a retirement account. If you rent it out, you can invest the income generated by the rental in a retirement account. If you decide to live in it, you could live the rest of your life mortgage- or rent-free if there’s no mortgage on the home and invest the money you were paying each month in a mortgage or rent in a retirement account.

The Tax Impact of an Inheritance

There may also be tax implications to receiving an inheritance that can significantly impact how much money you end up receiving to fund your retirement. Unless the estate is very large, you probably won’t have to worry about paying estate taxes. In 2019, the estate tax exemption is $11.4 million per person, or $22.8 million per couple. If the estate is smaller than this, estate taxes won’t be assessed.

However, if you inherit a traditional IRA or 401(k) account, the money will be treated as ordinary income when withdrawn and taxed at your ordinary income tax rate. You must make annual distributions from an inherited IRA regardless of your age. For this reason, it’s often smart to rollover funds from an inherited IRA into your own IRA so the funds can remain in the account and continue growing until after you retire and are ready to make distributions.

Plan Carefully

If you’re planning on using an inheritance as a major source of retirement income, you should carefully consider these and other factors during the years leading up to receipt of the inheritance.

Please give us a call if you have more questions about using an inheritance to help fund your retirement.


The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC's ("Frontier") investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.

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