Managing an inheritance: 7 things you need to know

Receiving an inheritance can be an emotional, life-changing experience that presents both new opportunities and challenges. Many people who inherit large sums feel a deep sense of responsibility to protect and properly manage the money—and do right by the loved ones who earned it.

“I watched my parents work night and day to grow their wealth,” says a Newport client who inherited a large estate. “I was determined to protect it.”

This two-part blog series will provide insights and information about how to manage an inheritance or how to prepare if a major transition of family wealth looms on the horizon.

In part one, we’ll outline the practical considerations you should plan for. In part two, we’ll explore the many feelings that can accompany inherited money and offer ideas for dealing with your inheritance in a way that is meaningful for you and your family.

A first step is coming to grips with the financial, tax, and legal implications of your inheritance. Here are seven points to consider:

1. Give yourself time to make informed decisions

Many of our clients describe the inheritance process as a whirlwind of first-time decisions.

Not only are you mourning the loss of a loved one; you may also see your wealth expand substantially or experience an entirely new financial reality.

“I went to bed one night with modest savings and woke up the next day wealthy after my grandmother passed away and I inherited her portfolio,” one Newport client told us. “I suddenly had to think of things that had never been on my radar.”

Newport Managing Director and Portfolio Manager, Stephen Hafner advises newly-wealthy clients—as well as those who already have significant wealth that grows greater with an inheritance—to take a deep breath and a step back.

“Working through probate and the legal aspects of settling an estate can take a year or longer before the wealth transfers into the inheritor’s name, especially if the estate structure is complex,” he says. “Take the time to get good advice, reflect on your options and make informed decisions to avoid costly mistakes.”

2. Understand the net proceeds before spending them

Depending on the assets you inherit and your relationship to the deceased, probate fees, capital gains tax and income tax will likely arise on the individual’s terminal tax return. It’s important that you’re clear on what the final proceeds from the estate will be. More than one inheritor has made financial decisions on the expectation of an inheritance that ultimately was less than expected.

While cash or securities are easy to value, property such as real estate, private investments or collectibles may require more involved valuation for tax purposes, and more time to liquidate.

When you know the final value of the inheritance, then it’s possible to start thinking ahead. Whether you plan to spend on luxuries, invest in a portfolio, pay down debt, develop a strategy to pass wealth along to the next generation, give some of the money away to charity—or perhaps all of the above—planning is in order.

3. Financial modeling will quantify your options

A good place to start is by working with your financial advisors to do an audit of your current assets and liabilities—including debts, income, spending, and property—as well as your future financial objectives. Your most important financial goals, both personal and professional, should be at the forefront of that discussion.

“We often build financial forecasts for inheritors that show how paying down debt, making investments, giving back through philanthropy or day-to-day spending will impact their cash flow and net worth over time,” Hafner says. “The goal is to help them achieve their lifestyle goals or plan for big expenditures such as a family cottage or early retirement.”

One portfolio manager watched a client purchase boats, cars and other luxuries after coming into a $2 million inheritance windfall. The client’s portfolio was draining fast, so the two sat down and had a frank discussion about the amount he could spend without running into trouble.

“I told him that if he kept spending that way, his inheritance would be gone in five years,” the portfolio manager recalls.

The client took the advice to heart and reined in his spending.

Developing an integrated financial plan—one that factors in tax, legal, investment and other considerations—will help create a roadmap to properly manage and protect your inheritance.

4. An investment portfolio should be tailored to your goals

If you’ve inherited a substantial investment portfolio from a loved one, your portfolio manager may remind you that it’s best to be objective when reviewing the holdings. That prized energy stock that’s been in the fold for 40 years? It likely won’t be the steady dividend grower in the future that it was in the past. In fact, some of the investments won’t align with your financial plan at all and will need to be sold.

Hafner stresses: “The stocks don’t own you—you own them.”

As one client shared with us: “My grandfather grew up in the Depression and always emphasized ‘protecting the farm’ and investing in majority blue chip, dividend-paying stocks. When I inherited his portfolio in my early 40s, I had a very different risk tolerance. I adjusted the asset mix somewhat, while staying true to what he taught me about conservative investing.”

5. You have new tax-planning opportunities to manage (and pitfalls to avoid)

“Inheriting large sums of money can produce significant investment income and corresponding tax liability, which needs to be managed,” notes Vincent Didkovsky, Vice President of Newport’s Wealth Planning Group.

As we’ve covered in past blogs, there are a wide range of strategies used to minimize taxes on death, as well as for estate planning, that if properly structured, will deliver a more favourable tax result for your family.

An experienced advisory team will customize a tax mitigation strategy that aligns with your financial and lifestyle goals. They’ll also highlight potential pitfalls.

6. It takes smart legal structuring to protect an inheritance

“The most important legal consideration is to ensure that you have updated wills and powers of attorney that reflect your new circumstances,” explains Ed Esposto, an estate lawyer and partner with Toronto-based law firm Aird & Berlis LLP.

A major inheritance necessitates the drafting or revision of your own estate plan and a new family succession strategy. And if the inheritance is tied up in a complex corporate structure, it may be challenging to unwind and will likely require the assistance of a specialized team of legal and financial advisors.

“One of our clients inherited a large estate with complex corporate and tax structuring,” says Newport Portfolio Manager Jordan Schwann. “The client wasn’t sure how to start untangling the legal web, so we’ve been working alongside her estate lawyer and accountant to help manage the process.”

Then there’s the matter of family ownership.

In Ontario, for example, gifts or inheritances received by a spouse while married are generally not subject to division with the other spouse upon breakdown of the marriage. The exception is if the inheritance is put into a joint account in both spouse’s names or if real estate is purchased with the inheritance proceeds and used as a matrimonial home. After that point, should the couple separate, those assets would be divided equally.

Growth and income (e.g., through accrued interest or investment returns) on an inheritance received while married are shared with the spouse on breakdown of the marriage, unless the will specifies to the contrary.

If you know that you or your children are preparing to marry and will one day be the beneficiary of a significant inheritance, pre-marital planning is essential.

If you’re planning to purchase U.S. property with your inheritance—say a winter residence in a sunny climate—another area that can trip people up is U.S. estate tax liability. Esposto says it catches many wealthy Canadians by surprise.

For example, U.S. securities or property for tax purposes, including real estate, could be subject to U.S. estate tax upon death—a rate that could reach as high as 40 per cent of the total value of the U.S.-held property.

The good news: “You can avoid that whole tax if you structure your estate appropriately,” Esposto says.

7. Your advisory team is your best support system

For some people, especially those for whom having significant wealth is a new experience, it can be challenging to put together and manage a team of advisors.

Schwann says his client, the one currently working to unwind her parents’ complex estate, now wishes she had put an advisory team together years ago.

“As she told me, ‘I’m great at running my business, but I don’t know anything about estate law or the complexities of tax structures.’”

Newport’s portfolio managers often quarterback this part of the process for clients, referring and working collaboratively with advisors such as accountants, lawyers and insurance professionals. When considering a wealth manager to help manage an inheritance, for example, consider a trusted individual or team that has excellent planning and communication skills, along with the empathy and experience of helping others manage a significant inheritance.

“Many people find their inheritance to be quite emotional because it came from family who worked hard to build it,” says Schwann. “They want to be comfortable with their investment manager and know there’s a safe pair of hands protecting that money.”

If privacy is a concern—particularly if you live in a smaller town or a tight-knit community—it may be best to work with an advisor based out of town or outside of your community.

With that advisory team by your side, you’re never alone when navigating the entirely new (and sometimes choppy) waters of inheritance and wealth management.

If you have questions about any of the practical legal, tax or investment considerations outlined here, contact a Newport Portfolio Manager at any time.

In part two, we’ll explore why so many inheritors feel a deeply held sense of responsibility to preserve and protect their new wealth, and the steps that some Newport clients have taken to ensure their inheritance was managed on their terms.