Estate planning usually involves the planning by an individual for the distribution of wealth. Often overlooked is how to handle the inheritance once it is received.
First, it should be noted that inheritance money from an estate, trust, or life insurance is not income to the recipient. Therefore, there will be no income tax due upon it.
The exception to this rule is money received from IRA’s, 401K’s, annuities, and similar retirement accounts. The money is income to the beneficiary and tax is due. This is not because it is an inheritance but because no tax was ever paid on the money. Accordingly, whether the individual who earned the money withdraws it, or beneficiaries receive the money after his or her death – tax must be paid.
This is important to remember because more than one individual has received inheritance that at least in part was from a retirement plan, used the money for a very large purchase, and then has been left scrambling at tax time.
Next, in Michigan, a gift or inheritance to an individual is not marital property. In other words, if one partner receives an inheritance, he or she will not be forced to share that money in the event of a divorce. This is true so long as the beneficiary does not co-mingle the funds.
While this can create discord in a marriage, it is important for the beneficiary spouse to keep the money in his or her own name alone and not place it in joint ownership. Once the money is put into joint ownership, its character changes from “mine” to “ours”. The same is true if the money is used or a jointly owned asset, such as the down-payment for a home that is in joint ownership.
These are important concepts to remember when receiving an inheritance. It is also an important item to discuss with your children when you are preparing your estate plan. Let them know what the rules are so that they will wisely use the gifts that you leave them.