Ask Liz Weston

Get smart with your money

Inheritance

Q&A: How to keep your spouse’s next spouse from spending your money after you die

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Dear Liz: I want to make sure that I leave an inheritance for my son from my first marriage. I remarried 12 years ago. My husband has no children. I do have a prenuptial agreement. My husband and I are financially fine. We own our own home and have adequate investments. I wouldn’t want to leave my husband without necessary funds, and he says he’ll make sure that my son gets an inheritance. But my husband’s father had dementia, and I am concerned that if my husband develops it, he may spend all the money on impulsive purchases. He has a tendency to make impulsive purchases now that we can afford them. What might I set up to ensure that my son receives an inheritance?

Answer: If you don’t make specific plans to leave money for your son, he may not get an inheritance even if your husband doesn’t develop dementia.

To put it another way: if you don’t want your spouse’s next spouse to spend your money, then talk to an estate planning attorney about your options.

You could, for example, leave part of your estate to your son and the rest to your spouse. Another possibility is to create a trust that gives your spouse income from your assets while he’s alive and then transfers the assets to your son when your spouse dies. Yet another is to name your son as the beneficiary to certain accounts, such as life insurance or retirement funds, while leaving other accounts to your spouse.

All of these options have advantages and disadvantages. An estate planning attorney can help you evaluate the best approach for your situation and draw up the needed paperwork.

Q&A: Inherited IRA taxes

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Dear Liz: I have about $16,000 in a Roth IRA that I plan to leave to my daughter. When she collects this on my death, does she pay tax on the withdrawals?

Answer: No. She would have to pay taxes on withdrawals if the money were in a regular inherited IRA, but not if the money is in a Roth. She will be required to withdraw the money within 10 years, though. Congress eliminated the so-called “stretch IRA” for most inheritors, so non-spouse beneficiaries can no longer stretch withdrawals over their own lifetimes.

Q&A: It’s easy to squander a windfall. How to make the money work for you

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Dear Liz: I’m receiving a $150,000 inheritance soon. After I pay all of my debt, I’ll have approximately $70,000. I’m 51, single with no children and my net income is about $4,400 a month. I’ve rarely been wise or successful with my finances. I have no prior savings, don’t own a home and drive a five-year-old car. Do you have any thoughts for the remaining funds?

Answer: It’s never too late to get better with money. Now would be a great time to examine why you got into debt and what you need to change so that doesn’t happen again.

Windfalls tend to disappear pretty quickly, and it would be a shame if you found yourself back in debt in a few years with nothing to show for your inheritance.

Nonprofit credit counseling agencies affiliated with the National Foundation for Credit Counseling (www.nfcc.org) usually offer help with budgeting, or you could book some one-on-one sessions with an accredited financial counselor or accredited financial coach. You can get referrals from the Assn. for Financial Counseling & Planning Education at www.afcpe.org.

Paying off high-rate debt such as credit cards is a great use of a windfall. Think twice about paying off lower-rate debts such as student loans or car loans, however. You probably have better uses for that money.

You likely need to start saving aggressively for retirement.

If you have a 401(k) at work with a match, you should be taking full advantage of that. (You might draw from your inheritance to replace some of the money that’s being directed into your retirement account.)

Otherwise, you can put up to $7,000 into an IRA or Roth IRA — the usual limit is $6,000, but people 50 and older can make an additional $1,000 catch up contribution. You can dedicate even more money for retirement by opening a regular brokerage account and investing through that.

A windfall also can help you create an emergency fund equal to three to six months’ worth of expenses, as well as provide a starter savings account for your next car.

Resist the urge to replace the one you have, though, because with proper maintenance you should be able to drive the one you have for several more years. Buying new cars every few years is hugely expensive and generally unnecessary since today’s cars can easily drive without major problems for 200,000 miles or more, according to J.D. Power & Associates.

Q&A: How to pass on inheritance to your children

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Dear Liz: I may inherit $500,000 but do not necessarily need the money for my retirement. Is there a way to pass that inheritance, or a part of it, to my two children without incurring a taxable event for myself or for them? I may want to ask my parents to add that to their trust or will.

Answer: You can “disclaim” or refuse to accept all or part an inheritance. If you do so correctly, the assets will pass to the next beneficiary as dictated by the estate documents (or by state law, in the absence of a will or living trust). If you think you’ll want this option, definitely discuss this with your parents and their estate planning attorney so the documents can be set up properly.

Keep in mind that few families have enough wealth to be affected by gift or estate taxes. Only people who give away millions of dollars in their lifetime have to pay gift taxes, for example. If you decide not to disclaim and later give the entire $500,000 to your kids, you wouldn’t have to pay gift taxes until you gave away considerably more. Plus, gifts are tax free to the recipients.

Gift and estate laws are always subject to change, so definitely consult a tax pro before making any decision regarding either.

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.