If you've struggled to get ahead financially for most of your life, you might see an inheritance from your parents as your best chance for becoming financially comfortable or even wealthy. However, counting on an inheritance to solve your financial problems is a bad idea. Receiving an inheritance requires the death of people you love, and you might not get the windfall you were expecting. Here's why.

See: Bursting Boomers' Inheritance Dreams

Your Parents Might Spend the Money Themselves
Your parents worked hard for decades to earn their nest eggs, and they may not be planning on leaving much behind. If they're fortunate enough to have more than they need to retire comfortably, they might spend the extra money on luxuries they couldn't afford when they were younger. Also, healthcare costs eat up a significant portion of most people's retirement savings, and with all the uncertainty surrounding Obamacare, it's impossible to predict what healthcare costs will look like in the future. If your parents live longer than anticipated, their retirement savings may simply run out. In fact, you might end up supporting your parents in their old age - quite the opposite of an inheritance.

The specific nature of your parents' nest egg could also limit what you receive when they die.

"Retirees that are currently in retirement tend to have defined benefit pension plans, and once they die, so does the payment stream," says Michael J. Fitzgerald, president of Fitzgerald Financial Partners, a Houston-based, fee-only financial advisory firm.

You Don't Know What You're Getting
Some parents tell their children exactly what they plan to leave them when they die. Others prefer to keep their financial affairs private. If your parents fall into the latter category, there's no point in counting on an inheritance because you don't know if your parents are planning to leave you $500,000 or $1. They might be planning to leave their assets to a favorite charity; they might not have any assets. If you have siblings, any money that your parents do leave will probably be divided among you.

A Typical Inheritance Won't Change Your Life
Many people don't receive any inheritance, and of those who do, the median inheritance for today's baby boomers is only $64,000, according to a 2010 study from the Center for Retirement Research at Boston College. That's nothing to sniff at, but it's probably not enough to dramatically change most people's lives.

In fact, you might burn through any money you do receive. San Francisco-based estate planning attorney John O'Grady, says that most people quickly spend an inheritance of any amount unless they purposefully create a long-term plan for the windfall. Without a plan, they may compulsively spend the money on big-ticket items, debt payments and donations, especially because they are not thinking clearly in the aftermath of a loved one's death. (For more, check out Leaving Inheritance To Children Easier Said Than Done.)

Probate and Taxes Often Take a Bite
If your parents don't do any estate planning before they pass away, the assets they leave you could take a significant hit from probate and taxes. Probate is the process by which a court reviews the deceased's will for validity and authenticity, and appoints the executor named in the will to distribute the deceased's assets. If there is no will, the person is said to have died "intestate." Probate will then appoint an administrator to distribute the assets according to state intestacy laws. Regardless of what your parents may have wanted, if they didn't correctly formalize it in writing, the state will make the important decisions about their assets.

The court and attorney fees associated with probate typically reduce the value of the deceased's estate by 3 to 7%. The estate administrator or executor may also charge a percentage fee; settling an estate can be a complex and time-consuming job. If anyone contests the will, these fees will increase. Also, probate can take as long as one to two years, which means that even if you are due an inheritance, you may be waiting longer than you thought to receive it.

Probate and its associated fees and waiting period can all be avoided by creating and placing property into a trust, but many people never establish trusts because they don't understand them or think they are only for rich people. But trusts aren't just for the wealthy, and a qualified estate-planning attorney can explain how trusts work and help parents select and establish the right trust.

Whether your inheritance will be subject to estate taxes depends on its size, and the ever-changing state and federal estate tax exemptions. In 2012, the federal estate tax exemption is $5,120,000.

The Money Could Come with Restrictions
If trusts have a drawback, it's that by placing their assets into certain types of trusts, your parents can continue to control their money even after they're gone. For example, parents can use an incentive trust to reward beneficiaries with trust money for particular behaviors, such as attaining a college degree, holding a job or working in the family business. They can also use trusts to punish undesirable behaviors, such as smoking and illegal drug use by withholding money from would-be beneficiaries. Trusts can also be set up so that beneficiaries don't receive the money all at once, but receive it gradually as they reach certain age milestones.

The Bottom Line
"Relying on an inheritance can diminish an individual's work ethic and feeling of self-worth," says Andrew M. Aran, CFA and partner with Regency Wealth Management in Midland Park, New Jersey.

Furthermore, there are numerous uncertainties surrounding whether you will receive an inheritance, and how large it will be. For all of these reasons, the best way to provide for your financial future is to take steps that you have complete control over, such as maximizing your income, minimizing your expenses, budgeting wisely and funding your own retirement account. (For related reading, see Encouraging Good Habits With An Incentive Trust.)

Related Articles
  1. Insurance

    Who is a Beneficiary?

    A beneficiary is a person or entity that receives funds, assets, property or other benefits from a trust, will, or life insurance policy.
  2. Professionals

    How to Protect Elderly Clients from Predators

    Advisors dealing with older clients face a specific set of difficulties. Here's how to help protect them.
  3. Taxes

    How to Tell if You Need an Estate Planning Lawyer

    Estate planning is an important and often neglected part of financial planning, which can be costly when avoided or done improperly.
  4. Retirement

    Inherited IRA and 401(k) Rules: Don't Run Afoul

    What you need to know when it comes to the complex rules for inherited IRAs and 401(k)s.
  5. Professionals

    How to Avoid the Inheritance Nobody Wants: Debt

    With the biggest transfer of wealth underway, advisors need to ensure that clients don't also inherit debt.
  6. Professionals

    Why the Wealthy Shy Away from Inheritance Talk

    A recent survey of high-net-worth individuals shows that many avoid talking inheritance with children. Here are some ways to balance the sensitive topic.
  7. Professionals

    How to Help Retirees Manage Taxes on Distributions

    There are many variables when it comes to helping retirees manage taxes on distributions. Here's what advisors need to consider.
  8. Term

    What is Wealth Management?

    Wealth management combines financial and investment advice, accounting and tax services, and legal and estate planning.
  9. Professionals

    Top Financial Planning Issues for Older Parents

    Clients who have children later in life present an opportunity for advisors. Here are the key the financial planning issues that need to be addressed.
  10. Professionals

    Top Financial Planning Strats for Unwed Couples

    Financial planning for unmarried or common law couples can be more complex. Here are some strategies advisors can implement to tackle this.
RELATED TERMS
  1. Duty Free

    Goods that international travelers can purchase without paying ...
  2. Wealth Management

    A high-level professional service that combines financial/investment ...
  3. See-Through Trust

    A trust that is treated as the beneficiary of an individual retirement ...
  4. Settlor

    The entity that establishes a trust. The settlor also goes by ...
  5. Personal Representative

    The executor or administrator for the estate of a deceased person. ...
  6. Tax Deductible Interest

    A borrowing expense that a taxpayer can claim on a federal or ...
RELATED FAQS
  1. Can I put my IRA in a trust?

    You cannot put your IRA in a trust while you are living. You can, however, name a trust as the beneficiary of your IRA and ... Read Full Answer >>
  2. How is cost basis calculated on an inherited asset?

    Typically, the cost basis on inherited assets is the fair market value as of the time of the decedent's death or actual transfer ... Read Full Answer >>
  3. How does the trust maker transfer funds into a revocable trust?

    Once a revocable trust is created, a trust maker transfers funds or property into the trust by including them in a list with ... Read Full Answer >>
  4. What is the difference between comprehensive income and gross income?

    Comprehensive income and gross income are similar, but comprehensive income is a specific term used on a company's financial ... Read Full Answer >>
  5. What is the difference between a revocable trust and a living trust?

    A revocable trust and living trust are separate terms that describe the same thing: a trust in which the terms can be changed ... Read Full Answer >>
  6. What tax breaks are afforded to a qualifying widow?

    The tax breaks accorded to qualifying widows or widowers include being able to use a tax filing status that allows for a ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!