Whether it is your goal or not to leave a legacy to your children, grandchildren, or other heirs, the fact of the matter is that virtually everyone will leave some kind of inheritance behind when they pass. And while most heirs would be grateful for any financial tailwind as well as the emotional value that comes with inheriting something from a loved one, some assets are more complicated than others to be passed to the next generation. Here are some of the top offenders:
- Vacation Homes or Non-Income Producing Property
Real estate in general can be a complicated asset to leave to your heirs, especially when there are multiple inheritors, who would need to agree on how the property was to be used, who would take on certain management and maintenance responsibilities, and if and when the property should be sold. Still more complications can arise when ongoing costs are incurred, such as property taxes, insurance, and maintenance – especially if the property does not produce sufficient income to cover those expenses.
Selling highly appreciated property during one’s lifetime can also be a less than ideal strategy, given the step-up in basis that occurs at the owner’s death. Therefore, it may be wise to proactively develop a plan for how the inherited property will be handled when that time comes.
- Family Business
Some families spend years growing a family business, often spanning over several generations, and so there can be a natural desire to see that continued with future generations. However, this can be problematic for everyone involved – the owner, the inheritor, and the business. It can be especially hard for the founder to “let go” of a business by selling the business to an outsider instead of handing it down, but the decision should consider several factors, including whether the next generation wants to continue the business, and whether there is more ongoing value in selling the business and making a hands-on transition while the owner is still alive.
Collectibles can also be a burdensome form of inheritance, requiring transport and storage, and in the case of valuables, potentially special insurance coverage and security (home safe, bank deposit box, etc.). Valueables that will be sold need to be valued, and potentially solicit help in finding the right buyers, all of which can be time-consuming and costly. Other issues can arise with particular items such as guns, which may require certain permits or registration, or items like instruments that may require proper storage and maintenance to maintain their value.
Just like with collectibles, physical property, even if it may carry sentimental value, comes with the burden of sorting through, transporting, and storing. Not to mention, absent proper planning and communication, trying to divide household and personal items can lead to disagreements when there are multiple heirs, especially when there is sentimental value. Personal belongings can be hard to divide, further muddying the water. It’s best to plan some of this out ahead of time and communicate that to the heirs, which sets expectations and can eliminate uncertainty and potential arguments.
What about the different types of financial assets?
While there are numerous rules and requirements to be aware of when it comes to the many different types of investment accounts, here are generally the best and the worst to leave to heirs:
The worst: HSA
The Health Savings Account can be a very tax-efficient savings vehicle, particularly when it comes to planning for medical expenses in retirement. However, the HSA receives the least favorable tax treatment as an inheritance. For non-spouse inheritors, the entire HSA balance is taxable in the year the successor owner dies. If you have other assets to leave a legacy, it is likely more beneficial to use HSA funds to pay for healthcare costs during your own lifetime and try not to leave a balance to children or other non-spouse heirs.
The best: Roth IRA
The Roth IRA is one of the best assets to leave behind when it comes to tax efficiency and flexibility. Like a traditional IRA, most of us who inherit a Roth IRA after 12/31/2019 from anyone other than a spouse will be required to distribute the full balance within 10 years. However, with a Roth IRA those distributions are completely tax-free to the beneficiary. And while they cannot be rolled directly into a personal Roth IRA, the funds can be used to support other personal finance goals, such as funding IRA’s and other retirement accounts, building up an emergency fund, etc.
When it comes to the taxation and distribution of inheritances, there are many rules and nuances for both the benefactor and inheritor to be aware of, so working with a CPA and an estate attorney in addition to your financial advisor is critical. It takes some thought and effort, but planning how you want your estate to be handled can help to ensure you leave both a good financial and relational legacy.
If you have specific questions regarding how any of your accounts or assets should be treated in your estate plan, we are happy to have a conversation with you.