Many people find it easier to discuss their weight or age than credit card debt or bank account balance. And when it comes to discussing money, there are few conversations as emotional and touchy as inheritance.
Parents are uncomfortable confronting their death and children don’t want to appear greedy or insensitive. So most families avoid discussing inheritance until a parent pases away — but by then it may be too late. Not having the inheritance conversation could lead to severe family strife and financial destruction.
Traditional views on inheritance are changing. According to a UBS Investor Watch report, most benefactors have an up-to-date will and about half claim they have discussed inheritance plans with their children. But that means half the benefactors out there have not had the difficult inheritance conversation. Whether it’s because they don’t like to talk openly about finances, don’t feel it’s a pressing issue, don’t want their children to feel entitled to wealth, or don’t want their kids to count on inheritance — many families choose not to engage in inheritance planning with their kids. And yet the report shows that families are happier and more satisfied when parents include heirs in the inheritance planning.
“Inheritance can be a complex and sensitive issue for both sides,” said Paula Polito, client strategy officer for UBS Wealth Management Americas. “But the fact of the matter is that it’s a conversation that needs to be had among families. Open lines of communication and advance planning are critical to ensuring a smooth transfer of wealth and to preventing future conflict among heirs.”
According to UBS, an estimated $40 trillion in personal wealth is expected to change hands by 2050. As people live longer, the inheritance conversations need to happen between benefactors and their heirs to ensure that assets are transferred successfully and as painlessly as possible. While discussing inheritance is an emotional and touchy subject, failing to do so might lead to expensive consequences, like these:
Disagreements over inheritance distribution happen when one heir doesn’t feel like he or she has gotten their fair share of assets or money. Research shows that when heirs don’t know the details ahead of time, they’re twice as likely to disagree with family about inheritance distribution. Why does one heir get more money than another? Why should one sister get more of the jewelry? Why does your brother get the property when you spent more time taking care of your dying mother? These are conflicts that can be avoided with proper planning and honest discussion. Lack of adequate preparation can ruin family relationships or even lead to expensive legal fees if families are torn apart by dividing a parent’s assets.
Discussing the transfer of wealth is uncomfortable, but necessary. If a benefactor plans to distribute his or her wealth unequally, that’s something that needs to be discussed ahead of time to reduce stress and conflict. Perhaps one child has a special set of circumstances and needs more money or maybe one heir is bad at managing their funds and therefore receives less than other kids. Explaining these decisions and having the dreaded inheritance conversations now will help diffuse any potential family conflict down the line. In fact, having that tough conversation might help an heir straighten out his or her finances now, which will only improve their financial outlook.
Benefactors who don’t prepare their heirs to receive an inheritance might put their children at risk, particularly if the inheritor hasn’t shown any acumen when it comes to managing money. For instance, the child might not know what taxes are liable for if they inherit property or a retirement account.
When an heir inherits property or cash from the estate of a benefactor, it’s possible that they will have to pay inheritance, estate or income taxes. Only a handful of states currently collect inheritance taxes, so unless you live in New Jersey, Pennsylvania or any of the other six states with this requirement, it’s not something you have to worry about. If you do have to pay inheritance taxes, you might be eligible to receive an exemption or reduction in the amount of tax that you have to pay depending on your relationship with the deceased. As far as estate taxes go, federal estate taxes have exemptions that you should look into and only a handful of states collect estate taxes. In general, an inheritance is not considered income and you will not have to pay income taxes, but any earnings on inherited assets are taxable. So if you inherit cash, you will be taxed on the interest paid. If you sell inherited property, it’s generally taxable.
In some scenarios, an heir might inherit a retirement account from their parent. Inherited retirement assets aren’t taxable until they are distributed. There are different rules that may be applicable to you, particularly if you are an heir as opposed to a spouse of the deceased. The tax issues that arise when you inherit a retirement account — such as an IRA or 401(k) — can be complicated, so it’s best to consult with a tax adviser if you have questions.
Tax laws change frequently, so even if an heir understands what they have to pay for inheriting cash, property, or a retirement account, it’s important to check for the latest information from the IRS. As always, an heir should consult a financial advisor if there are any questions regarding inherited property.
Having the conversation
According to the UBS report, both parents and their children agree that the bonus is on benefactors to raise the inheritance issue. After all, the money belongs to the benefactor and he or she is going to decide what to do with it ultimately. So parents, you’ll have to tough it out and initiate the inheritance conversation.
Approaching the dreaded inheritance conversation doesn’t have to be all doom and gloom. There are ways that you can simplify the wealth transfer process. First, understand that there are no all-encompassing rules that you should follow — dynamics differ greatly from family to family, so what works for you might not work for someone else. That said, one approach that might ease the burden of discussing inheritance is to do it gradually. Don’t just drop a big inheritance bomb out of the blue one day. You can better prepare your kids to manage an inheritance windfall from a young age by creating a family mission and sharing stories about how your family wealth came to be. Of course, teaching your kids smart money habits — creating a budget, managing credit in a responsible way, establishing financial goals — will go a long way, too. Because your kids aren’t likely to learn about personal finance in school, the burden is on you to teach them how to properly manage their money.
Once your kids are older, assess how responsible they are with money and think about what they would do with your inheritance. What good will a big windfall do if your kid spends it buying an expensive car? You don’t want your kid to waste their inheritance, but at the same time bad financial habits are hard to break. In these instances, you can continue to guide your child, but also consider requiring them to undergo financial training in order to receive their inheritance.
Another tip: Don’t be too quick to reveal to your heir that they will receive an inheritance. No one should count on inheritance money to fund any big purchases. Kids should learn how to be responsible with money on their own. That way, they will learn how to manage their own finances and hopefully spend your inheritance wisely.
If you don’t trust yourself to have the inheritance conversation, consider using a third-party financial professional to map out your inheritance planning. Above all else, have a sound plan so that you have the difficult inheritance conversations now — before it’s too late.