Experts say . . .
Inheriting is a whole new world for most of us. Here
are some frequently asked questions about investing and inheritances
with answers from Bankrate.com experts Dr. Don and the Dollar Diva.
What is the best
way to defer paying tax an IRA my brother and I inherited from our
received a $10,000 inheritance and need help deciding how to invest
My wife died this
year with several stocks held in her trust, with me as the beneficiary
of the trust. What would the cost basis of those stocks if I were
to sell them?
I received an inheritance
that is about the same amount as my outstanding mortgage balance.
Should I pay off my mortgage and invest my monthly mortgage payments,
or should I invest the entire lump sum?
What is the
best way to defer paying tax an IRA my brother and I inherited from
When a spouse inherits an IRA,
he can roll it over into an IRA of his own. Unfortunately, sons
and daughters do not have that option; they have to take distributions
and pay tax on them. However, you won't pay early withdrawal penalties
for taking these distributions before age 59-1/2.
Your mother's IRA documents
and the Internal Revenue Service regulations determine how you can
receive the money. If the IRA allows it, the best way to defer taxes
on your inheritance is to elect to spread the distributions out
over the longest period available to you. The rules are complicated,
but knowing that your mother was more than 70-1/2 when she died,
there are some general guidelines. First, you need to know what
method your mother used to calculate her life expectancy for her
IRA distributions: term-certain or recalculation.
Term-certain: With this method, life expectancy is
estimated from the tables provided in IRS Publication 590, Individual
Retirement Arrangements, and the IRA account balance is divided
by the life expectancy to determine the first year's distribution.
Each subsequent year, this estimated life expectancy is reduced
by one year to provide the denominator for calculating the annual
distribution. For example, if the table estimates a life expectancy
of 20 years and the IRA balance is $400,000, the first year's distributions
would have to total $20,000. The next year, the remaining balance
would be divided by 19, the following year by 18.
If this method were used and you were a designated
beneficiary, distributions can be made over the joint life expectancy
of your mother and either you or your brother. (When more than one
beneficiary is on the account, the life expectancy of the eldest
is used.) This will be a much longer period than if you had inherited
the IRA as a beneficiary of her estate and distributions had to
be made over your mother's shorter life expectancy.
Designated beneficiary means your mother named you
and your brother as beneficiaries on her IRA account. Otherwise
you would have inherited the IRA as a beneficiary of her estate.
Recalculation: With this method, the tables in the
IRS Publication 590 would have been checked each year to determine
her new life expectancy, and her IRA balance would have been divided
by that number to determine the annual distribution amount.
The upside of this method is that the payments are
stretched out over a longer period of time. The downside is if you
were not designated as a beneficiary, you would have to take the
entire distribution by Dec. 31 of the year following your mother's
death. I hope you are a designated beneficiary so you can stretch
distributions out over your life expectancy and enjoy some tax deferral.
The rules are complex. For specific information, look
at IRS Publication 590; get a copy of the IRA document, and talk
to the IRA administrator to see what your options are and what will
work best for you.
recently received a $10,000 inheritance and need help deciding how
to invest it.
Ask yourself what personal goal
you want to work toward and that will help you decide how to invest
the money. Most investors want two things from their investments:
to get back what they originally invested (principal) and to earn
a return on their investment that increases the purchasing power
of the invested principal.
The further away the goal, the more money you should
have in stocks. Stocks have a track record of returning more than
bonds or money market investments when investing for the long haul.
If you are saving for retirement and retirement is 15 years to 25
years away, then choose a no-load mutual fund that invests in a
broad-based market index of stocks.
If your financial goal isn't quite so far away, you
should have more of the money in bonds. Bonds are often called fixed-income
investments because the return on the investment is contractual,
or fixed. As long as the company meets the terms of the bond agreement,
the investor will be paid the interest and principal payments on
the bond. Default is possible with corporate or municipal debt.
U.S. Treasury securities have no risk of default. I like buying
individual bonds or CDs vs. a bond mutual fund, but a mutual fund
will spread any default risk over more issuers.
Invest in money market mutual funds (or MMF, for short)
when you expect that you will need the money within a year or so
of investing the funds. MMF investments are very safe, and it's
highly unlikely that you would lose any principal. These investments
are easily converted to cash. Many MMFs allow the investor to write
checks against the balances in the fund.
So, the shorter the investment horizon, the less risk
you should take with your investment. But try not to look at the
inheritance by itself. What percent of your total investment portfolio
does this represent? How will that change over time? How likely
is it that you will have to sell the investment to meet some unanticipated
future need? If you expect pension, Social Security and 401(k) money
will pay for your retirement, then you shouldn't invest the inheritance
for that horizon.
My wife died
this year with several stocks held in her trust, with me as the
beneficiary of the trust. What would the cost basis of those stocks
if I were to sell them?
The basis is the amount you would report on your individual
tax return as the "cost" when you sell the stock. There
are two possibilities:
Stepped-up or stepped-down basis: The amount you report
as "cost" is the market value of the stock at the date
of your wife's death.
This generally occurs when stock is inherited, and
the value of the stock is included in the decedent's estate for
estate tax purposes even if no estate taxes are required.
Carried-over basis: The amount your wife would have
reported as "cost" if she had lived is the same amount
you would report as "cost" when you sell the stock.
Carried-over basis usually occurs when stock is received
as a gift. It can also occur when inherited stock is not included
in the decedent's estate for estate tax purposes because, for example,
the decedent had only a life income interest in the trust and never
personally owned the stocks.
Ron Aucutt, an estate tax attorney with McGuire, Woods,
Battle & Boothe LLP, in McLean, Va., says he would need to know
what kind of trust your wife had to determine the stock basis. He's
suggesting two possible scenarios:
1. The stock will have a stepped-up or stepped-down
basis if the trust is a revocable living trust with the following
- The trust is set up by your wife, who is the beneficiary
until her death.
- You become the remainder beneficiary, or you receive
the stock outright when she dies.
- The value of the stock is included in her estate
for estate tax purposes, even though there will be no estate tax
due on the stocks passed on to you.
- There is an exception: If any of the stocks in
the trust were given to her by you within one year of her death,
the basis of those stocks would be carried-over.
2. The stock will have a carried-over basis if the
trust had the following characteristics:
- The trust was set up by someone else, perhaps her
- Your wife is the beneficiary until her death.
- You become the remainder beneficiary, or you receive
the stock outright when she dies.
- The value of the stock is not included in her estate
for estate tax purposes.
The stepped-up feature of appreciated stocks makes
them a sweet way to remember your loved ones when you die.
an inheritance that is about the same amount as my outstanding mortgage
balance. Should I pay off my mortgage and invest my monthly mortgage
payments, or should I invest the entire lump sum?
Let's say the inheritance is $205,000
and so is your mortgage balance. Let's also say that you have a
30-year fixed-rate mortgage at 8 percent, with a payment of $1,500
per month and a full 30 years to run. If you keep the mortgage,
you'll pay a total of $540,000 with $335,000 of that being mortgage
interest expense. The interest expense will save you about $110,550
in federal income taxes (at the 33 percent marginal tax rate). You
can invest the $205,000 and it will be worth about $2,242,000 30
years from now, assuming an 8 percent annual after-tax return, compounded
If you pay off the balance and invest $1,500 monthly,
at the end of 30 years the investment will be worth about $2,250,000;
again, assuming an 8 percent annual after-tax return, compounded
monthly. But you'll have paid an additional $110,550 in federal
income tax over the years due to the loss of the mortgage interest
The portfolio values are close enough that the decision
really hangs on the tax benefit. The portfolios are $8,000 apart
and most of that difference is attributable to rounding. I'd chose
to invest the lump sum. It gives you financial flexibility that
you may need down the road and allows you to keep the tax deduction.
The tax savings could be invested over the years to add to the value
of the portfolio. Assuming that you'd receive the same tax benefit
each year, invest that at 8 percent after-tax, compounded annually,
and the tax savings are worth $417,000 at the end of 30 years.
-- Posted:Aug. 7, 2001