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Leaving or Receiving—How to Manage an Inheritance

The Smart Way to Manage an Inheritance
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Demetra Sullivan, Schwab’s vice president of portfolio consulting, talks about the potential pitfalls to avoid when you give or receive an inheritance.

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Janet:
Inheritances—at some point in our lives many of us will either receive or bequeath one. But knowing how to best manage this money, whether you’re on the giving or receiving end, can be a bit of a challenge. We’ll speak with Demetra Sullivan, vice president of portfolio consulting at Charles Schwab, to learn more about inheritances and their implications for our finances.

You’re listening to the Insights and Ideas podcast brought to you by Charles Schwab. I’m Janet Alvarez. In this installment we’ll explore the ins and outs of inheritances, including common pitfalls to avoid. Demetra Sullivan suggests some useful techniques for protecting your family’s resources and ensuring a lasting legacy.

Hi, Demetra, thank you for joining us today.

Demetra:
Hi, absolutely. It’s my pleasure.

Janet:
Demetra, inheriting money is a right of passage for some families. It’s an intergenerational transfer of wealth that allows younger generations to get a leg up in life. But what do inheritances look like in America today? What’s the average inheritance amount these days?

Demetra:
Well, based on some recent studies that I’ve been taking a look at, it appears that the average inheritance in the United States, at least, is about $177,000. So that is a pretty substantial amount for a lot of families. And in other circumstances, it may not cover what the individual receiving the inheritance thought it might. So it’s an important conversation, I think, to have as you’re thinking about family planning and multigenerational planning, et cetera. So glad we’re having the conversation today.

Janet:
The estate tax, also known as the inheritance tax and the death tax, first appeared in the United States in 1898. It was called a succession duty and applied to estates with a value of over $10,000. But by 2001 the estate tax rate was 55% of all estates over $675,000. Since then Washington has exempted larger fortunes from the tax, while lowering the rate and even abolishing it for one year in 2010. As of 2016, the estate tax rate is 40% on estates of more than $5.45 million or $10.9 million for couples.

Janet:
What can you tell us about the estate tax, and how can families minimize its impact?

Demetra:
Sure. So one very common strategy that you probably hear a lot about is a trust. So a trust is an estate-planning tool that can accomplish a number of things. And it’s not just about taxes. It can protect against incapacity, avoid probate, allow for professional management of assets, designate care for minor children or special-needs family members, and even protect assets from future creditors. A colleague of mine used to say that a trust can protect against creditors, predators, in-laws and outlaws. And I thought that was a great way to remember it.

So different types of trusts can accomplish a number of very effective planning needs. Be it ensuring that assets stay within the bloodline of the family or planning for an income stream for a family member as opposed to a lump-sum inheritance or even accomplish philanthropic goals. So there are marital trusts, credit shelter (bypass) trusts, grant or retained annuity trusts, charitable remainder trusts, and charitable lead trusts. So there’s a whole number of different trust techniques, and it just depends on your personal circumstances to see what makes the most sense for you and your family.

Janet:
So it sounds like trusts aren’t just for high-net-worth families. Can middle-class families also make good use of them?

Demetra:
Absolutely. And so as I mentioned, it’s not just about how to handle estate taxes or potential estate taxes. It can also be about just taking care of your family or beneficiaries you really care about. I think the most important thing is to speak with your estate planning attorney and CPA to discuss your unique circumstances and determine what type of planning makes the most sense for you.

I certainly wouldn’t consider myself in an ultra-high-net-worth situation personally, but I do have minor children, and so it’s really important to me that we do some type of planning, and a trust has been part of our planning for our family.

Janet:
So Demetra, what are some of the most common mistakes people make when they receive inheritances? And how can they best protect themselves from those mistakes?

Demetra:
You know, one of the things that we see, unfortunately, is that some of the simple things, like just designating the right beneficiary according to what your family dynamics look like today, has not been done or it’s been overlooked. So for many of the clients we speak with and people I talk to, one of the first steps I’d say is just take a look at the titling and beneficiary designations on all of your assets to make sure that they’re up to date. Because of changes in family dynamics, be it due to deaths or divorce or other changes, it’s important to make sure that the current titling and beneficiary designations are up to date.

Unfortunately, that’s one that we see happen quite frequently. The other is just being able to take into consideration whether a lump-sum inheritance is really the right thing for the beneficiaries that we’re thinking about. So whether it be a minor child or someone with spendthrift provision needs—depending on what’s going on with those beneficiaries and their personal life situation, thinking about lump-sum inheritances and what that can do to them or for them is really important. Because there’s a lot of planning that can be done in advance to take care of that type of circumstance.

Janet:
So, Demetra, can you elaborate a little bit on the spendthrift provision? What it is, what it entails and how we can benefit from it?

Demetra:
Sure. So with spendthrift provisions within a trust, what it allows you to do is plan for the inheritance that’s being passed on to a beneficiary to be distributed in a really structured way. What we’ve seen in terms of challenges with individuals receiving lump-sum inheritances is that it might not be what’s truly in the best interest of that person, just based on the financial decisions that they make personally or just the life decisions that they make personally.

The grantor of the trust may want to structure that inheritance in a way that allows, for example, an income stream or certain provisions to really protect that money from creditors, for example, or other unintended beneficiaries.

Janet:
Is it possible to create provisions that would either lapse or sunset or in any way change should the conditions of the trust not be met after your death?

Demetra:
Sure, yeah.

If there are certain passions that you have or interests that you have for your family or the recipients of those funds down the road, when it comes to drafting the trust, you can really customize that however you’d like. I know folks who might be specifically interested in having the next generation—maybe it’s their grandson, granddaughter—attend their alma mater.

Janet:
And one last question today, Demetra. It’s a fun one, at that. If you inherited a million dollars tomorrow, what would you do with it?

Demetra:
Well, I’m a financial planner first, and so it’s probably not as exciting as some answers you might get. But I think about things like what’s going to impact my family first. So I have a 4-year-old and a 2-year-old and am well aware of what’s going on with college expenses.

So planning for their college and life needs down the road for them is first on my list. I’d stick with family. Second would be my parents. Make sure that things are OK for them and their retirement needs. And then if I had a little left over, because a million dollars doesn’t necessarily go as far as you think, I’d probably take my dad helicopter skiing. That’s one of our bucket-list items, and I’d put that one in there.

Janet:
Demetra, thank you very much for joining us today.

Demetra:
Thank you so much. It’s been great.

Janet:
What would you do with a million dollars? The better question to ponder may be “what wouldn’t you do.” That’s because roughly 70% of people who receive a windfall, such as an inheritance, spend the entire amount within a few years, according to the National Endowment for Financial Education. That’s why preparing yourself for an inheritance is so important. It can help protect your money from your most impulsive tendencies.

Janet:
Demetra Sullivan is vice president of portfolio consulting at Charles Schwab.

That’s it for this installment. The Insights and Ideas podcast is brought to you by Charles Schwab. You can find us on iTunes or Insights.Schwab.com. Thanks for listening.

Important disclosures

The investment and tax strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment or tax strategy for his or her own particular situation before making any decision. Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or geopolitical conditions.

Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

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