Beyond Losing Money in the Stock Market: Here's How a Parent's Death Could Affect You Financially

You work really hard to invest, take control of your assets and plan for the future. You think you're doing just fine with your net worth and managing your assets, then your only living parent passes away. 

It could throw a huge wrench into your finances, even if you do receive money from your parent upon his or her death. Let's take a look at how they could trounce your finances and how you can minimize it.

Long-Term Care Could Devastate You

Do you have a parent currently in a long-term care facility? If you do, you may have already experienced the unreal costs of nursing home care. If your parent doesn't have long-term care insurance, a private room in a nursing home costs more than $100,000 a year. You'll have to pay that out of pocket. A home health aide can also cost more than $50,000 per year out of pocket.

At this point, your parent probably won't qualify for long-term care insurance if he or she is elderly. 

How to minimize the impact: There's not much you can do if your parent doesn't have sufficient assets and needs long-term care. However, you may want to consider getting long-term care insurance so you don't devastate your children's finances in turn. 

Estate Taxes Could Reduce Your Inheritance

Estate taxes could impose a large bill on you. If your parents' estate is over $11.4 million, you pay a tax on the overage. In general, the tax rate is between 18% and 40%. Granted, you'll still have several million in your pocket upon your parent's death, but some states also levy an inheritance tax as well, and one state takes both estate and inheritance taxes. Six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania) have an inheritance tax, and Maryland collects both estate and inheritance taxes.

Inheritance tax rates often depend on the heir’s relationship to the deceased. More distant relatives or heirs who aren't related to the deceased usually have to pay the highest inheritance tax rates.

How to minimize the impact: Heirs can decline an inheritance through an inheritance or estate waive, which allows you to decline the rights to the inheritance. The executor of the will would then name a new beneficiary, and state law determines how those work.

Generation-Skipping Transfer Taxes Could Affect Your Kids

Generation-skipping transfer taxes apply to estates that owe federal estate taxes when the estate passes a gift or inheritance to a beneficiary at least 37½ years younger than the deceased. In other words, it could involve your parents passing on assets to your children. 

Prior to rules implemented in 1976, families went to estate planners, who created life estates for kids, grandkids and great-grandkids which weren't subject to federal estate tax. They could pass money from generation to generation without any risk of paying estate taxes, because life estates weren't subject to estate taxes.

The federal estate, gift and GSTT exemption was set at $11.18 million for each individual and $22.36 million for married couples by the Tax Cuts and Jobs Act, which went into effect on January 1, 2018. 

How to minimize the impact: Encourage your parents to use the annual gift tax exclusion ($15,000 yearly and a lifetime exclusion of $11.7 million in 2021) while they're still alive. Your parents can also make direct payments to certain education and health care providers for qualified tuition and medical expenses.

You May Lose Out Through Income Taxes

The executor of your parent's will must file a final income tax return on the normal due date of April 15 of the year preceding your parent's death. The trustee, executor or administrator must file Form 56 so the IRS knows he or she will be the person responsible for the final tax return. 

All income up to the date of death must be reported and all credits and deductions to which the decedent is entitled may be claimed. 

However, if your deceased parent owes taxes, you'll need to make any final tax payments, including both federal and state tax payments.

How to minimize the impact: If you cannot afford to pay those taxes, the IRS can help you set up a payment plan.

RMDs Apply to Inherited Accounts!

You probably already know that you must adhere to required minimum distributions (RMDs) after age 70 ½. However, if you inherit these types of accounts from your parent, they can also be subject to RMDs. This could affect your tax situation. The RMD is taxed as ordinary income and stacks on top of your current earnings.

How to minimize the impact: If your parent is still alive while you're reading this, you could ask him or her to do Roth conversions while living so their beneficiaries can avoid the tax hit, because Roth distributions are non-taxable. Your parent would have to pay taxes to convert a traditional IRA into a Roth IRA, however. It can make sense to convert if you are in a higher tax bracket than your parent.

Mind When You Must Take Distributions

In the past, you could ride out distributions from IRAs for the duration of your life if you chose. However, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, non-spouse beneficiaries of an IRA must take full distribution of all amounts held in the IRA within the 10th year of your parent's death. Otherwise, you get taxed heavily.

Several exceptions to this SECURE Act rule exist: Beneficiaries designated as the surviving spouse, a child of the IRA owner who has not reached adulthood, disabled or chronically ill individuals and individuals who are not more than 10 years younger than the IRA owner.

How to minimize the impact: Talk to a tax advisor. Depending on when you need the assets,  you might want to withdraw in equal or irregular installments over the entire 10-year period, depending on your situation and tax bracket.

Talk with a Tax Advisor About Your Parent's Assets

It's a good idea to talk to a tax advisor about your parent's assets while your parent is still alive. It's especially important when he or she doesn't have a surviving spouse (because most of these tax hits go away in the case of a surviving spouse). You can also get more information about the step-up in basis and other caveats, particularly if your parent is interested in increasing savings for you and other heirs.