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Inheritance: How to handle a million-dollar windfall

May 9, 2011: 12:25 PM ET
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(MONEY Magazine) -- When their mother died of cancer in June 2007, Pattie Cagney Sheehan and her four siblings inherited the Hinsdale, Ill., three-bedroom ranch where their parents had lived. Estimated value: just over $1 million.

Everyone agreed that selling was the best move. Problem was, the property, while in good condition, lingered nine months before a buyer came along, dribbling money from the estate in the meantime and turning a still-grieving Cagney Sheehan, executor of her mother's will, into a referee.

"One sibling," she recalls, "was firm that the house was priced right; another was equally convinced it was much too high. The other two were swing votes."

When she wasn't on the horn with her brother and sisters (or busy liquidating her mom's portfolio or meeting with a lawyer or an accountant), she was making sure the lawn was mowed, the snow cleared, the utility bills paid. "And if the alarm went off, I was the one who was called," says Cagney Sheehan, 58, who lives in Chicago. ('A $2 million windfall -- and other inheritance stories')

Eventually the house sold, for only 9% less than their initial estimate, and Cagney Sheehan was able to find solace in the end result: A former marketing exec, she used her share of her mother's legacy to open a boutique that sells bras and wigs to cancer patients -- a new life that wouldn't have been possible without the bequest.

Her experience sums up the duality of inheritances. Being remembered in a loved one's will can provide consolation, along with the obvious material benefits. But it may also present thorny challenges: The tough choices over what to do with Mom's house, Dad's investments, or their business are often fraught with administrative complexity, tax consequences, and a heavy helping of family drama.

Moreover, at the time these critical decisions come up, the beneficiary's judgment may be clouded. "People are in a very emotional place after the death of a parent," says Heidi Horsley, a Manhattan psychologist specializing in grief counseling. "They're not always completely rational."

Chances are, you'll find yourself grappling with these issues in the near future, if you haven't already: Among the wealthier half of baby boomers, 75% will get a bequest in their lifetime from a parent or other older relative, a recent study for MetLife found. The median amount: $159,000, including home equity.

The strategies that follow will help you navigate the most common challenges beneficiaries face and make the most of your inheritance -- just as Mom or Dad would have wanted.

The inheritance: A house or other property

The challenge: Driven by emotion, beneficiaries are often tempted to keep the family homestead or vacation property. But unless you plan to live there, doing so means doubling up on housing costs -- and that can hinder your progress toward other goals, says Raleigh financial planner Rick Parkes.

Of course, selling can be costly, too, if the property first needs fixing up or languishes on the market. Matters are further complicated when the decisions must be made by committee, as typically happens when there are multiple heirs.

The solution: How to proceed depends on what you -- and others who share the bequest with you -- want to do with the property.

  • If you'd like to keep it:

Get a handle on exactly how much you'll be on the hook for between property taxes, insurance, any mortgages (including home-equity lines or reverse mortgages), and maintenance. Also, hire a home inspector -- expect to pay around $500 -- to tell you how much you'll need to shell out for repairs; find one at ashi.org.

Can you afford it? The hard numbers can help remove the emotion. When Robert Paas's mother died, for example, he and his sisters considered keeping her Florida beach-front condo as a vacation home.

Once they discovered how much it would cost to insure and maintain, however, they had a change of heart. "You know what? It's cheaper to stay in a hotel for a month," says Paas, 46, a former Army staff sergeant from Royalston, Mass.

If you decide to keep the property and there isn't money in the estate to pay off the mortgage, you'll need to refinance in your own names.

Sharing Grandpa's summer home with siblings or cousins? Have an attorney draft an agreement spelling out cost sharing, usage splits, and buyout terms, and put the deed in what's known as a limited liability company. While it may seem impersonal, this arrangement -- which costs $5,000 to $10,000 to set up -- will help avoid bickering down the road, says Rockville, Md., estate attorney Brian R. Della Rocca.

  • If you want to sell:

With the real estate market still depressed, temper your expectations. It could take months to find a buyer. So that upkeep doesn't eat away at your inheritance, use the strategies in "Hard Sell for a Soft Market" to speed the sale.

On the plus side, when you do sell an inherited home, you'll owe taxes only on the increase in value since the purchaser died or six months after that, your choice.

  • If co-inheritors disagree:

The simplest solution is to have whoever wants to keep the property buy out the others. Not an option? You could also force a sale through a lawsuit called a "partition action." But don't count on an invitation to Thanksgiving dinner this year -- or ever.

The inheritance: Retirement accounts

The challenge: Inheriting an IRA, 401(k), or 403(b) can be win-win: You not only get money but the opportunity to grow that money tax-free. Trouble is, to take advantage, you must correctly navigate complicated options. And the most tempting of these -- withdrawing a lump sum -- will put you at a tax disadvantage.

You'll lose the benefit of deferral and usually pay the biggest bill to Uncle Sam. "Many people don't realize this," says Jim Blankenship, a financial planner in New Berlin, Ill. "The next April, they get a big surprise."

The solution: No matter what kind of account you inherit, your first move should be to transfer it to a "beneficiary" IRA. (If the account was already an IRA, you can simply retitle it.)

That way you'll have the option to withdraw over your lifetime -- meaning you must take minimum distributions every year, based on an IRS schedule. If your deceased loved one was younger than 70½, you'll also have a secondary option that allows you to delay payments for a few years, but you'll have to empty the account by the fifth year.

Your best bet, typically, is to take the lifetime option and withdraw only the minimum each year. Smaller withdrawals over a longer period will help keep you in a lower tax bracket, so the IRS will take a smaller cut of your inheritance. (This doesn't apply to Roth IRAs, the distributions from which are tax-free except for earnings withdrawn within five years of when the original account was opened.)

Plus, you'll enjoy years of tax-advantaged growth on the balance, says Brooklyn CPA and financial adviser Barry Picker. The end result: more money for you.

Bill Boaz, 58, a retired securities salesman living in Tucson, also discovered an emotional benefit to the lifetime pay option. "It's like I get a check from my father every year," he says. "There's some comfort in that."

The inheritance: A bequest with strings

The challenge: When assets are passed down through a trust, there may be rules about when you'll get the money and how you can spend it. Your loved one may have stipulated, say, that you won't receive your share until a certain age, that you can only draw an amount equal to your earnings, or that you must use the funds for your kids' college education.

You won't face legal restrictions on assets inherited through an ordinary will, but you may feel constrained by emotional strings -- maybe your dad told you what he hoped you'd do with the money or you simply know what would please him. Either way, you may feel stuck if your loved one's desires don't match up with your own.

The solution: Recent laws have made it easier to alter certain terms of a trust out of court, says Cincinnati estate attorney Michael Schwartz. But this road is most fruitful when the deceased's intent is ambiguous, and other beneficiaries support the change. If you can't get others onboard, learn to love the ties that bind -- taking the case to court can be costly and has slim odds of success.

As for informal or unspoken instructions, try a compromise: Put some of the money toward the cause your parent noted, and use the rest as you see fit. If the request was ambiguous, trust that your parent would trust your judgment.

Upon receiving a $140,000 inheritance from her mother last May, Daffney Harris, a social worker in Decatur, Ala., recalled her mom saying, "When I pass, make sure you do something for my grandchildren." So she put $40,000 into a 529 plan for her 2-year-old daughter's college, using the rest to shore up her family's other savings. "I followed her directions," says Harris. "She should be well pleased. I am."

The inheritance: Stocks or other taxable investments

The challenge: Securities can sometimes be as laden with emotion as family photos are. Maybe a trove of company stock represents the decades your dad spent at his job, or you remember how your parents used the dividends from their blue-chip funds to send you to college.

Unloading the investment might feel like a rejection of their values, says Syracuse financial planner and CPA Ted Sarenski. On the other hand, keeping the shares may not be in your best interest: A stock that was a buy 40 years ago may be a dog now; a big stake in a single holding could throw off your overall allocation.

The solution: Imagine your parents had given you a sweater that was too small. Do you think they'd rather you walk around in the cold or exchange it for something that would keep you warm? Most likely, they'd want what's best for you.

So figure out if their investments fit that bill. First get a handle on the prospects for the stocks and funds you've inherited with an eye toward weeding out losers. (Ask your financial adviser or use research tools at sites like valueline.com and morningstar.com.)

You'll also want to be sure that none of the investments you've received will make up more than 10% of your portfolio. Morningstar's Instant X-Ray tool (morningstar.com/tools.html) can show you how the securities will affect your allocation.

If your head says sell but your heart disagrees, chip away at the shares rather than dumping them all at once, suggests Livingston, N.J., financial planner Michael Kay. You might sell 10% to 20% every six months. (You needn't worry about creating a monster tax liability: The capital gains will be based on the securities' value at the time of the purchaser's death.)

Finally, frame an odd-lot certificate from your parents' files -- or buy one at scripophily.com -- so you can honor their past without handicapping your future.

The inheritance: A family business

The challenge: Taking over a business founded by a parent is hard enough for one person -- you may feel you have big shoes to fill. Things get trickier when more than one child inherits.

Arguments surface about whom Dad trusted (or should have trusted) to run it. And the hardworking heir who's toiled for years alongside parents may blow up at the sibling who drops his surfboard only long enough to collect a check.

The solution: Immediately hire an interim manager if there's any uncertainty about succession. "A void in leadership could be a time bomb," says Don Schwerzler, a family business consultant in Atlanta.

Assuming you're not involved in the business, use this time to figure out how it's doing (bring in an outside CPA) and whether you have the interest and skills to run it.

If more than one person wants to be boss, each should list his or her talents, says Mark Colgan, financial planner and author of The Survivor Assistance Handbook.

Meanwhile, have the highest-ranking nonfamily employees detail the qualities that leadership requires. "See who's the better fit," says Colgan. "Maybe it's neither."

Those who decide not to be involved should sell their stakes, says Cincinnati wealth adviser and CPA Mackey McNeill. Otherwise, she says, resentment can undermine the business.

A small-business appraiser can help you set a price for the shares. A common arrangement, if the buyer can't pay upfront, is to pay out of cash flow over a few years. Your parents might have dreamed that co-ownership would bind siblings together, but selling out may do more to keep their real legacy -- the family -- intact.  To top of page

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