How To Handle Inherited Investments

Dated: 01/07/2020

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Office file folder in a business.  Legal will for inheritance

Investors need a plan to properly manage an inheritance.(GETTY IMAGES)

RECEIVING AN inheritance can be a double-edged sword.

On the one hand, it's overwhelming, thanks to the intense emotions associated with losing a loved one combined with the confusion about what to do with the newly acquired assets. On the other, an inheritance can re-invigorate your finances and create new opportunities for you and your family.

Most inherited assets are unmanaged. The best way to understand this is to imagine your grandfather leaving you his investment portfolio after he passes away. If he doesn't stipulate what you can do with it or when you get it, his gift is unmanaged.

Meanwhile, when your inheritance is managed, that typically means you are the beneficiary of a trust, which not only distributes assets on a prearranged schedule but sometimes sets limitations on how they can be spent and on whom.

Here are some top inheritance considerations:

  • Consider cash.

  • Beware of concentration risk.

  • Understand trusts.

Consider Cash

Outside of cash, the most common types of inheritances include securities, real estate and, somewhat surprisingly, art. While these assets tend to rise in value over time, perhaps the more significant benefit is their favorable tax treatment.

Heirs do not pay capital gains on unsold investments that rose in value during the lifetime of the deceased (though estate taxes would apply). Those taxes would only apply to the gains that occurred after they took possession. So there is reason for holding onto these investments.

Yet, artwork can be stolen or damaged. Real estate can get ravaged by destructive weather events. And market forces can render some securities entirely worthless. (Think about someone who inherited now-bankrupt Sears' stock just before the financial crisis, when it traded at $144.)

So, be prepared to consult experts, whether it's an art appraiser, real estate broker or financial advisor, to help navigate the potential risks.

It could be that converting some of your inherited investments into cash, cash equivalents or life insurance products with a guaranteed payout is the best option. Whatever the case, all investors should try to avoid exposure to holdings that present undue risk to their current financial plan.

Beware of Concentration Risk

It is common for an inheritance to be heavily concentrated within a specific asset. This may occur when the deceased held lots of stock in the company where they worked. Other times, it could be that they gobbled up real estate in a particular area or thought the works of a specific artist would skyrocket. Or maybe they put every last penny into Tesla years ago because they were an early believer in Elon Musk's vision of transforming the world.

Even if the deceased's instincts were spot on at the time of their initial investment, there is no guarantee that their strategy will continue to pay off long term. Anyone, for instance, who invested in Tesla at the time of its IPO and held on to their holdings is undoubtedly happy today. But the company faces challenges and the market could be due for a downturn after more than a decade of near uninterrupted gains, so the tide may turn.

Therefore, diversifying into other areas, even with high-volatility vehicles that are uncorrelated to the original inherited investment, can reduce that concentration risk. A still safer move would be to build a portfolio of diverse holdings that includes multiple asset classes across different sectors, perhaps through a mix of passive and active management style mutual funds or exchange-traded funds.

Understand Trusts

Sometimes when people inherit assets through a trust, they don't think it's important to have anything but a superficial understanding of how these legal arrangements work, since the trustee assumes nearly all the fiduciary duties. But that could change when a beneficiary reaches a certain age, which often sparks a dissolution of the trust or stipulates a transfer of trustee responsibilities to them. Then what happens?

It's also possible that you decide to set up a trust of your own, creating a no-nonsense way to distribute part or all of your unmanaged inherited assets to heirs in a timeline and under conditions in which you are most comfortable – all without having to go through the probate process.

Regardless, you should understand how trusts work. Learn the difference between revocable and irrevocable trusts; grantor retained annuity trusts and charitable lead annuity trusts; asset protection trusts and special needs trusts. That way, even if you choose not to manage or establish a trust, you can make a well-informed decision about what to do with your inherited investments.


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Mark Ross

For Mark Ross, founder of Ross NW Real Estate and professional real estate broker, real estate has always been the career of choice. During his 25+ years in the industry, Mark has gained experience in....

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