6 minute read

Inheritance 101: How Inheritance Works

Have questions about inheritance money? Learn exactly what an inheritance is and how it works, including how to set up your own inheritance specifications.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Share this article

There’s a significant inheritance puzzle that waits to be solved. According to surveys cited by SmartAsset, there’s a difference between the amount of inheritance Americans plan to receive, versus what they plan to leave. The difference is a staggering $108,000 on average.

The answer to this large puzzle: a lack of proper estate planning. Passing on your assets and property doesn’t happen automatically. It’s something you need to plan for through creating a Trust or Will. 

If you’re planning to either leave or receive an inheritance, then you’ve come to the right place. Keep reading to get your general inheritance money questions answered, along with a breakdown of how inheritance works.

What is an Inheritance ?

An inheritance is the collection of assets you might receive from a loved one when they pass away. It can include such things as:

  • Cash

  • investment assets such as stocks or bonds

  • Real property, including land and real estate 

  • items such as jewelry, furniture, collectibles, and family heirlooms

As an example, let’s say that a grandmother passes away and leaves all of her assets to her granddaughter. The granddaughter’s inheritance includes the money saved in her late grandmother’s checking and savings accounts, her house, clothing, jewelry and car.

[Top search result for this query after Dictionary schema is https://www.investopedia.com/terms/i/inheritance.asp

How Does Inheritance Work? 

An inheritance describes the assets you’d like to leave to a loved one, who is in this case called a beneficiary. If you’d like, you can have multiple beneficiaries.

The way an inheritance works will differ based on whether or not you’ve created a Will that clearly defines what assets you’d like to gift, and to whom. 

In the first scenario, let’s pretend that you passed away, and you didn’t create a Will. Perhaps you verbally promised your house to a relative, and your cash assets to another.  In this case, your estate becomes intestate. This means that all of your assets will be combed through in detail through a painstaking process called probate. Each state has different intestate laws, but generally, your assets might be divided up in a way that you didn’t wish for. Refer to our guide on what happens to your money if you die without a will for more information.

You might have guessed it already, but the second scenario is preferable. In this scenario, you had set up your estate plan and a detailed Will. In the case that you pass away, your assets will not have to go through probate, and will be allocated to your beneficiaries per your instructions.

How Do You Receive Money from a Will?

Let’s continue on with the example from earlier and pretend that your grandmother recently passed away. Your grandmother told you verbally that she named you her beneficiary in her Will. You’re probably wondering what the actual process of receiving money from the Will looks like. 

In her Will, your grandmother would have named an Executor. This individual is responsible for making sure that the wishes in your grandmother’s Will are carried out dutifully. Executors are commonly attorneys or trusted family members. There are several steps they must follow before they can give you your inheritance.

Step 1: Asset Inventory

The Executor’s first task is to obtain your grandmother’s estate planning documents, including the Will, along with other important documents. Bank statements, house deeds, car titles, and insurance policies are all examples of documents that must corroborate what was delineated in the Will. Any outstanding bills must also be collected. The Executor may be required to present this information to a probate court, depending on the state.

Step 2: Asset Valuation

Next up, the value of your grandmother’s assets must be calculated. The courts require a listing of all assets in the inheritance, as well as their date-of-death value. If you as the beneficiary decide to sell any of the assets, you’ll be assessed capital gains tax. Although taxes are unavoidable, getting the date-of-death valuation is a good thing. It’s called step-up in basis, meaning that you’re only going to be taxed on the gains you made from the date-of-death value, and not from the prices at the time the assets were originally acquired.

 Step 3: Bill Pay

If your grandmother had any outstanding bills, they must be resolved before you can receive your inheritance. Here’s a list of common types of bills that are often outstanding upon a person’s passing:

  • Utility bills

  • Medical bills

  • Credit card payments

  • Personal loans

  • Mortgages

The Executor is responsible for notifying creditors of the death. Oftentimes, a notice will be placed in a newspaper, along with instructions on how to report a claim within a set time limit. Any disputed claims could go before a judge, which can complicate things and extend the timeline.

Step 4: Taxes & Returns

In the second to final step, the Executor will then file any required federal and state estate taxes, inheritance taxes, and final income taxes on behalf of your grandmother. Any taxes owed must be paid at this time.

Step 5: Distribution

Finally, it’s time for the inheritance to be distributed to the beneficiaries. Distribution of the inheritance is the last step because all bills and taxes must be paid. As the beneficiary, you don’t want to be held liable for any unpaid bills or deal with legal battles. 

What Happens When You Get an Inheritance?

As we outlined in the section above, there are several steps that need to happen when you’re given an inheritance. The Executor must submit the Will and other important documents to the probate court, and then pay any outstanding bills and taxes. Once that’s done, you can expect to receive a disbursement of financial assets and transfer of ownership of any tangible assets. The Executor will follow the instructions included in the Will to make this happen. As you might imagine, this process can take several weeks to months.

Other Frequently Asked Questions About Inheritance

If you have more questions about how inheritance works, it’s only natural. No one’s a “pro” at receiving inheritance money, and it is a somewhat complicated process. Here are some answers to common questions.

What are Inheritance Taxes?

Many states assess an inheritance tax. That means that you, as the beneficiary, will have to pay taxes when you receive an inheritance. How much you’ll be assessed depends on the state you live in, the size of your inheritance, the types of assets included, and your relationship with the deceased. Taxes are an important part of your inheritance planning, so be sure to check out our special guide that’s dedicated to everything you need to know about the inheritance tax.

What Should You Do if You Inherit Money?

Coming across a windfall doesn’t guarantee you security. Some beneficiaries even end up worse-for-wear, after making irrational decisions and lifestyle changes after receiving an inheritance. What you do with your inheritance is a completely personal decision, but in general, there are some ways you can be smarter with your money.

First, consider working with a financial advisor. These are financial professionals who are trained to help you create a financial plan. They will likely have tips on how to pay off your debts, and how to invest your inheritance to grow your wealth safely.

Second, do your best not to spend all of your inheritance. This can be an emotional time, and you may not be thinking clearly. Instead, set your inheritance money way in a savings account, and revisit it at a later time when you can be more logical.

Finally, spend some time prioritizing your financial goals. Do you have debts you can pay off? Are you behind in saving up for retirement? Do you want to put more toward your child’s college savings account? Your inheritance could be a great way to catch up and get ahead, if you use it wisely.

How to Set Up Your Inheritance

On the opposite end of receiving an inheritance, there may come a time when you want to pay it forward and set up an inheritance for one or more loved ones. This can be done by establishing an estate plan. Follow these simple steps to get started:

1. Perform a Review of Your Assets

Before you do anything, you’ll need to assess exactly what you can include in your inheritance. It’s a worthwhile exercise to sit down with a notepad and write down everything you can think of. It could be your cash, your house and any other property, your car, jewelry, and any other belongings that would be of any monetary or sentimental value. 

2. Create Your Last Will and Testament

Once you have your list of assets to include in your inheritance, it’s time to create your Will. Although the Will can pertain to other important agenda items, this is where you can delineate the contents of your inheritance. You’ll list out what you would like to gift, how much, at what timing, and to whom.

3. Name Your Executor and Beneficiaries 

Don’t forget to name your executor and beneficiaries in your Will. The executor is the individual who will be responsible for making sure your wishes are properly executed. Because of this, it’s recommended that you pick a trusted person who can remain impartial in case of any family disputes. Your beneficiary (or beneficiaries) will be the individuals receiving the inheritance that you set up. Be sure to be specific about who gets what, and how much, because any vagueness in your Will can cause confusion, or worse, disputes amongst family members.

4. Consider Setting Up A Living Trust

If the total value of your assets amount to $160,000 or more, you may want to consider setting up a living trust. A trust is a fiduciary agreement that allows your assets to be managed by a third party that you appoint. That way, the Trustee can distribute your assets per your wishes from the Trust account. A living trust allows you to set it up and continue controlling the assets while you’re alive. It’s another added layer of protection. Learn more about this in our guide on Trusts and why you might want one.

5. Organize Your Documents

An important part of sound estate planning is good document organization. First and foremost, always plan to perform a routine review of your estate planning documents. Make sure that only the most up-to-date version is accessible to prevent confusion, and shred outdated and thus invalid versions. Your system should also include any important documents that accompany your Will or Trust, such as bank statements, deeds or titles, or anything that will help prove the legitimacy and value of the items listed in your inheritance. Last but not least, include instructions for accessing a password manager that contains the login information for any online accounts and digital assets.

An inheritance can be overwhelming, on both the gifting and receiving end. It might be exciting to receive a sudden windfall, but there are legal procedures and due process that must be followed before you can get your inheritance money. If you’re the gifter, it will take quite a bit of preparation and documentation to ensure your assets can be passed on. However, it’s all worth it when making sure that your legacy can be passed down from generation to generation. Here at Trust & Will, we can make the process a lot easier and smoother. Check out our platform and see how you can do it all online in a few simple steps!

Is there a question here we didn’t answer? Reach out to us today or Chat with a live member support representative!

Share this article