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Issues to Consider for Those Receiving an Inheritance

With an economy whose sands shifted dramatically just as boomers reached peak midcareer earnings years, many found themselves lacking in the retirement savings they’d assumed.

While the millennials — the generation born between 1980 and 2000 — are getting the bulk of attention from marketers, the baby boomers still have plenty of room to make their economic presence felt.

According to a 2013 study commissioned by MetLife and conducted by the Center for Retirement Research at Boston College, the boomer generation stands to inherit a total of $8.4 trillion, in 2009 dollars, from their parents or older relatives.

For many boomers, born between 1946 and 1964, this can be nothing short of life-saving. With an economy whose sands shifted dramatically just as boomers reached peak midcareer earnings years, many found themselves lacking in the retirement savings they’d assumed.

Among the study’s findings:

  • Most boomers will receive their inheritances in late middle age, upon the death of their last surviving parent.
  • A whopping two-thirds of all boomers stand to receive some inheritance during their lifetime.
  • Many of the boomers have or will receive a significant sum of money from their parents while the older generation is still living. That increases the total wealth transfer from $8.4 trillion to $11.6 trillion.

That’s the great news.

But once you’ve received your inheritance, what comes next? Should you simply leave the money with Dad’s broker, who is perhaps in another city and with whom you’ve rarely (if ever) had contact? Do you assume that whatever investments your parents held are also appropriate for you? Is the money enough to last throughout your own retirement, or does it need to be supplemented with other income sources?

Over the years, one of the most common reasons new clients contact our firm is because they have recently received their inheritance, and they want some guidance on how to proceed.

Here are some problems we have observed. If you receive an inheritance, these are worth considering, as they may dramatically affect the amount you ultimately have available for your own retirement goals.

Is Mom or Dad’s portfolio right for you? There’s no sentimental value to a stock, bond or mutual fund. Most of the time, our parents invested differently than we do today. There are very good reasons for this. Namely, the science of investing, based upon nearly 60 years of Nobel Prize-winning research, was not fully understood or widely known until the past 25 or 30 years.

In the past, American investors were largely limited to U.S. stocks and large stocks, in particular. For many people, it feels safer to invest in a large familiar name, as opposed to a smaller company you’ve never heard of. That didn’t go so well for people who socked away a lot of cash in big, trusted companies like Eastman Kodak.

More to the point, research has emerged over the past 30 years showing the small stocks, over time, outperform larger counterparts. In addition, your parents likely had little or no exposure to international stocks and bonds. Granted, it was more difficult to purchase international stocks in the past, before today’s inexpensive, passively managed funds made them more accessible.

The boomers are fortunate that we have much better investment choices today, thanks to ongoing academic research into market performance. That batch of large American stocks is actually riskier than you might think. If you hang onto the inherited portfolio without making changes, you may find yourself experiencing bouts of market volatility that could be smoothed by a more diversified group of investments.

You don’t have to put up with a portfolio that was constructed for a different era.

That portfolio might be costing you a lot. Today there is a growing use of what’s called a passively managed fund. This just means that no highly paid manager is sitting around making bets on how he or she believes the market will do.

This type of management is something Mom and Dad may not have known about, but you should.

The typical actively managed mutual fund of our parents’ era was built around a manager who attempted to beat the market (mostly with little success, as is well documented by Standard & Poor’s, Dow Jones and other sources). Sadly, these funds carry high fees and no performance oomph to make the extra cost worthwhile.

It’s very easy to do a portfolio diagnostic to determine whether actively managed funds are causing undue performance drag. As you look ahead to retirement, isn’t it worth using all the 21st-century tools at your disposal?

Watch the capital gains. If you inherit an investment portfolio, capital gains taxes could become a big problem if you are not very careful. This applies to accounts other than an inherited Individual Retirement Account, which has a more favorable tax treatment.

Often, we see boomers who inherit accounts that are structured as “taxable,” meaning that capital gains taxes must be paid on the profits from an investment that is sold. For example, if you paid $10,000 for stock and sold it for $30,000, you would owe taxes on the $20,000 capital gain.

Fortunately, when you inherit stock, the cost basis — or the amount paid — is deemed to be “stepped up” to the date the former owner died. In plain English, say your mom, not you, bought those shares of stock totaling $10,000 back in 1980. She held them until she passed away in September of this year, when the shares were worth $100,000.

If you inherit mom’s portfolio and decide to diversify your portfolio and make it more efficient to meet your goals, you don’t owe capital gains taxes on that entire $90,000 gain. Instead, your new cost basis is deemed to be the date your mother passed away.

This is good for the boomers. However, we’ve seen portfolios that were inherited and for whatever reason, were not diagnosed immediately for risk, hidden fees or capital gains taxes. In those cases, it’s sometimes too late to make beneficial changes in one fell swoop; instead, positions must be handled “surgically” to avoid a hefty tax bill.

If you recently inherited a portfolio, it’s wise to get an opinion from a fee-only financial adviser who can give an accurate assessment of the portfolio’s pros and cons. As boomers, we want to honor our parents and show gratitude for what they left to us. Part of that means shepherding their gift wisely.


Did you recently receive an inheritance, and want to be sure it’s invested correctly?

Better Money Decisions can help. Schedule a no-obligation call with an advisor.

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