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Inheritance

All or part of the assets of an estate that are passed on to the heirs after the death of the estate owner

What is Inheritance?

Inheritance refers to all or part of the assets of an estate that are passed on to the heirs after the death of the estate owner. The inheritance may be in the form of a cash endowment, real estate, stocks, etc. Usually, the owner of the estate writes a will on how his or her wealth will be distributed to the heirs, and it only becomes executable after the person dies.

 

Inheritance

 

Sometimes, the owner of an estate may die without writing a will, and it complicates the process of determining the rightful heirs of the estate. Such estates are transferred according to the laws existing in specific states on the distribution of inheritance to the descendants.

 

How Inheritance is Distributed

The following are the basic steps of distributing wealth to the beneficiaries of a deceased estate owner:

 

Estate Planning Process

The asset distribution to the descendants of a deceased owner of an estate is determined during the estate planning process. In this process, the owner of the estate identifies all the descendants that are due to receive a portion of the inheritance. The owner lists all the assets that he/she owns, which can be real estate, stock certificates or even cash endowment. The will specifies who receives what in the list of assets, and the asset distribution method may be influenced by the estate owner’s religion or culture.

For example, in Jewish laws, the inheritance is passed only to the male descendants and the female descendants are left out in the wealth distribution. It can only be passed to female descendants if all sons are deceased, and there are no living descendants of the deceased sons.

 

Probate Process

For the inheritance process to begin, the will must first be submitted to a probate court. The probate court is required to collect and distribute all the assets of the deceased according to the distribution preferred by the deceased in the will.

The court undertakes the process by authorizing the executor of the will to legally transfer the wealth to beneficiaries as outlined. However, any debts owed by the deceased to creditors, investors, and the government must be paid first before any distributions are made to beneficiaries.

 

Inheritance Distribution Without a Will

In the absence of a will, the court will distribute the wealth according to the rules set by the state where the deceased was a resident. One of the general rules is to determine the wishes of the deceased by checking if there are beneficiaries who had been appointed in retirement plans, stock certificates, and real estate property.

Once the beneficiaries have been identified, the court will authorize the executor to commence the inheritance transfer process to all the identified beneficiaries. Due to the difficulties of distributing wealth without an existing will, the probate process can take several months or years before the process is completed.

 

Inheritance Restrictions

When writing the will, the owner of an estate may put certain restrictions as to who is paid, how much is paid and how the inheritance is used. One of the common restrictions is that money can only be transferred to beneficiaries once they reach majority age, or when they achieve certain milestones such as college graduation or marriage.

The other restriction is how wealth is distributed to the beneficiaries. Due to the possibility of misuse of the inheritance, a person may require the inheritance to specific beneficiaries to be made in small installments rather than in lump sum payments. A person may also limit how the inheritance is to be spent. The beneficiaries may be limited to spending the wealth on specific uses like medical expenses, education, upkeep, etc.

 

Inheritance Tax

 

Inheritance Tax

An inheritance tax is a tax charged on the inheritance distributed to the descendants of a deceased person. It is different from the estate tax, which is charged on the value of the assets left behind by a deceased person. In the United States, there is no federal government tax, but individual states charge inheritance tax on the inheritance distributed to heirs of a deceased resident.

The amount of inheritance tax charged on an individual depends on their relationship with the deceased, and the value of the inherited properties. As of 2018, the states that charge inheritance tax include Nebraska, New Jersey, Pennsylvania, Kentucky, and Maryland. There are more states that charge an estate tax (20 states as of 2018) compared to the states that charge an inheritance tax.

Typically, tax thresholds are higher for beneficiaries without familiar relationships with the deceased, while close relatives are either exempt or taxed a lower rate. For example, the amount of wealth inherited by the spouse (s) of the deceased is usually exempt from taxation. The children of the deceased are also exempted in some states or charged a lower tax rate.

Distant relatives like uncles, aunts, nieces, nephews, and other blood or adopted relatives are charged a higher tax rate. For example, as of 2018, the state of Nebraska charged children, parents, and grandparents of the deceased an inheritance tax rate of 1% for inheritance exceeding $40,000 while distance relatives like aunts and uncles are charge an inheritance tax of 13% on inheritance exceeding $10,000.

 

Additional Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Arrears
  • Contingent Beneficiary
  • Solvency
  • Types of Assets

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!