Ask Liz Weston

Get smart with your money

Inheritance

Q&A: Who inherits when estranged spouse dies?

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Dear Liz: I lost my husband a year ago. We had been married since 1997 but separated 10 years ago. Does the house belong to me or my 22-year-old son? Also, how do I find out if he had life insurance without being charged a lot? His girlfriend said he did.

Answer: The two most important factors here are whether you were legally separated and whether your husband made a will. If you were legally separated, there may have been an agreement approved by a judge that could affect how assets are divided. If the separation was informal, then the law typically treats you as if you were still married.

If your husband had a will, that would dictate who gets what. If he died without a will, then state law determines how to divide what’s left after his final expenses and creditors have been paid. When someone is married and has children with the current spouse, typically the entire estate would go to that spouse. Otherwise, half usually goes to the spouse and the rest is split among other heirs, such as children from another union.

This assumes the house wasn’t jointly owned with someone else, such as your son or the girlfriend. Property held in joint tenancy, tenancy by the entirety, or community property with right of survivorship will automatically pass to the other owner at death.

“Consulting with an attorney or trusted CPA, checking title to the real property and reviewing mortgage statements should be done to help determine their rights and how to proceed,” said estate planning attorney Jennifer Sawday of Long Beach.

If you would be the beneficiary and probate hasn’t been started, consider hiring a probate attorney to put that process in motion. The person settling his estate can look through his bills and other paperwork for evidence of life insurance, or you can try the life insurance policy locator maintained by the National Assn. of Insurance Commissioners.

Q&A: Should you sell a house or let heirs deal with it? The taxes shake out differently

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Dear Liz: My mother, who will be 101 later this year, is leaving me real estate in her trust. The value of it is $4.5 million. She has other assets that will put her estate over $5 million when she passes. I currently have an offer from someone who wants to buy the real estate. Is it better for her to sell it now and reduce the value of her estate? She has never exercised the option for the one-time sale of her primary residence tax free. What are the tax implications if it remains in her estate until she passes?

Answer: There’s no such thing as a one-time option to sell a home tax free. Decades ago, homeowners could defer the recognition of taxable gain if they bought another house, and homeowners 55 and older could exclude as much as $125,000 of gain. That was a one-time deal, so perhaps that’s what you’re remembering.

Since 1998, however, taxpayers have been able to exempt as much as $250,000 of capital gains from the sale of their primary residence as long as they owned and lived in the home at least two of the prior five years. Taxpayers can use this exemption as often as every two years.

Clearly, your mom needs to find a source of good tax advice, such as a CPA or other tax professional. If you have the authority to act on your mother’s behalf through a power of attorney or legal conservatorship, then you should seek the tax pro’s advice as her fiduciary.

Under current law, if she retains the real estate it would get a “step up” to the current market value as of her death. That means all the appreciation that happened during her lifetime would never be taxed. If she sells now, on the other hand, she probably would owe a substantial capital gains tax bill, even if she uses the exclusion. The tax pro will calculate how much that’s likely to be.

That tax bill has to be weighed against the possibility that her estate could owe taxes. The current estate tax exemption limit is $11.7 million, an amount that will continue to be adjusted by inflation until 2025. In 2026, the limit is scheduled to revert to the 2011 level of $5 million plus inflation. President Biden has proposed lowering the limit to $3.5 million and modifying the step up, but those ideas face stiff opposition in Congress.

An estate planning attorney could discuss other options for reducing her estate if she’s still with us as 2025 approaches. The tax pro probably can provide referrals.

Q&A: Here’s how taxes work on estates and inherited money

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Dear Liz: Are all assets entitled to a stepped-up basis upon the death of the owner? My father died about a year ago, leaving my sister and me an estate of a little over $1 million. He had a Thrift Savings Plan that is apparently like a 401(k) for federal government employees. This is getting taxed at 37%. Also he had U.S. Savings Bonds and the interest on those is apparently taxable. I was under the impression all assets in an estate under $11 million were not taxable. Is this not correct?

Answer: That’s not correct. You’re confusing a few different types of taxes.

Estate taxes are levied on certain large estates when the owner dies, and those taxes are typically paid out of the estate. The current estate tax exemption limit is $11.7 million, up from $11.58 million last year. After 2025, the limit is scheduled to drop to $3.5 million, but even then very few estates will owe the tax.

Another type of tax is the capital gains tax. This essentially taxes the profit someone makes when they sell a stock or other asset. Capital gains tax rates are typically 15%, but they can be as low as zero or as high as 20%, depending on the seller’s income.

Inherited assets that qualify for capital gains tax treatment also can qualify for the “step up in basis” that may reduce the tax bill, sometimes dramatically. If your dad paid $10 for a stock that was worth $100 when he died, you could sell it for $105 and owe taxes only on the $5 in appreciation since his death. The $90 appreciation that occurred during his lifetime would never be taxed.

Not all assets qualify for capital gains treatment, however. Retirement accounts, including 401(k)s and IRAs, are a good example.

People usually get tax breaks when they contribute and the accounts grow tax deferred. When the money comes out, however, the withdrawals are taxed as income regardless of whether it’s the original owner getting the money or the heir. Whoever makes the withdrawal pays the taxes.

Federal income rates currently range from zero to 37%. The 37% rate applies for singles with taxable income of $523,601 or more and married couples filing jointly with taxable incomes of $628,301 or more.

Q&A: Withdrawals from an inherited 401(k)

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Dear Liz: A relative inherited a 401(k) as a listed beneficiary, and it was simply rolled over into an IRA in her name. Now another family member wants some of the money. The relative keeps trying to explain that if she pulls out any or all of the money, it will be taxed and reduce the amount available if she did want to share it. She is already retired and doesn’t need to use the money. She wants to keep it as part of her joint estate with her spouse, who could possibly use it later to pay off their mortgage. Wouldn’t she be foolish to pull the money out just because another family member thinks he should get some of it?

Answer: Your relative needs to talk to a tax professional.

Required minimum distribution rules prevent people from keeping money in retirement accounts indefinitely, and the rules recently changed regarding inherited retirement accounts. Your relative needs to understand the rules that apply to her, since failing to follow those rules can incur hefty penalties. Exactly how those rules apply depends on when she inherited the money and her relationship to the deceased.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 eliminated the so-called stretch IRA, which allowed non-spouse beneficiaries to minimize distributions so that inherited retirement accounts could continue to grow tax deferred for decades. Now, non-spouse beneficiaries are typically required to drain the account within 10 years of the original owner’s death. These rules apply to retirement accounts inherited after Dec. 31, 2019. Even if she inherited the money earlier, she would still need to begin distributions at some point. Failing to make these required distributions incurs a tax penalty equal to 50% of the amount that should have been withdrawn but wasn’t.

Of course, just because she has to withdraw the money and pay taxes on it does not mean she has to cave to the family member. The withdrawals are hers to spend, invest, share or save as she wishes.

Q&A: Dad didn’t trust banks. How to handle the hoard he left behind

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Dear Liz: My father was eccentric and given to conspiracy theories. He didn’t trust banks or the stock market and invested the bulk of his money in gold coins and bars. We are talking millions of dollars at current gold prices. My parents set up a living trust, so when my mother dies, I am confident the gold will be distributed equitably to myself and my siblings, without a lot of hassle in probate. But I have no idea how to convert all that gold into a more liquid investment like an IRA or money market fund. How do I do it and not be overwhelmed with fees and taxes?

Answer: Let’s hope the gold is safely stored and properly insured. It would be a shame if burglars walked away with your inheritance.

If your mother’s estate is large enough to owe estate taxes, the estate will pay those — not the heirs. (The current exemption is more than $11 million per person, so very few estates owe this tax.)

Under current law, the gold will receive a new, “stepped-up” value for tax purposes on the day your mother dies, said Jennifer Sawday, an estate planning attorney in Long Beach. You should note the price of gold on that day, using a reliable gold pricing site, and print out the information for future tax purposes, Sawday said.

Once you receive the gold, you can take it to a precious metals exchange and cash it in. If the price you get is higher than the price of gold on the day your mother died, you would have a taxable capital gain. If the price is lower, you would have a capital loss. You wouldn’t owe any taxes and could use the loss to offset capital gains elsewhere or, if you don’t have gains, as much as $3,000 of income per year until the loss is exhausted.

You can deposit the cash in a bank account, or open a brokerage account and choose your investments from there. Those investments might include a money market fund as well as stocks, bonds, mutual funds and so on.

An IRA is a type of retirement account, not an investment, and requires you to have earned income to contribute. The contribution limit is $6,000 this year, or $7,000 if you’re 50 or older, so you wouldn’t be able to put much of your inheritance into an IRA in any case.

An excellent use of some of this cash would be to hire a fee-only, fiduciary financial planner who can help guide you on how to invest the money wisely and with an eye to minimizing taxes.

Q&A: A sudden death brings a financial quandary

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Dear Liz: My son suddenly passed away and his $1-million life insurance policy was awarded to me, his mother. I want the money to be divided equally between his two children for future use. They are 18 and 15 now. What financial vehicle should I use? The funds are in my money market account just waiting to be placed into something.

Answer: Please use some of the money to pay for individualized counsel from advisors who are fiduciaries. Fiduciary means the advisor is required to put your best interests first. Most advisors are not fiduciaries but you can find financial planners who are through the National Assn. of Personal Financial Advisors, the XY Planning Network, the Garrett Planning Network and the Alliance of Comprehensive Planners.

The vehicle or vehicles you use for the money will depend on your goals and how you want to distribute the funds over time. You’ll need good advice about how to invest, minimize taxes and incorporate the money into your own estate plan. Distributing money to your grandchildren can trigger the need to file gift tax returns, although you wouldn’t actually owe gift taxes until you’d given away millions of dollars.

Your son may have chosen you as his beneficiary because he trusted you to do right by his children. Or he may not have updated his beneficiaries since applying for the policy. (More than a few ex-spouses have wound up with life insurance proceeds because the policy owner didn’t update the beneficiaries after the divorce.) It’s a good idea to check the beneficiaries on any life insurance once a year or after any major life change to make sure the money is still going where you want.