Inheritance is a topic that many people avoid discussing, but it is a significant part of financial planning. Among the various assets that one might inherit, stocks are some of the most common. The process of inheriting stocks involves a series of legal and financial steps, which we will explore in detail in this post.
Understanding Stock Ownership
Ownership of stocks comes in various forms, each with its unique set of rules and implications, particularly when it comes to inheritance. Understanding these ownership structures is crucial when planning for the future of these assets.
An Individual Account is a standard brokerage account in one person’s name.
- Inheritance Scenario: In the event of the account holder’s death, the stocks held in an individual account will typically become part of the deceased’s estate, unless a beneficiary has been designated through a TOD (Transfer on Death) or POD (Payable on Death) designation.
- Probate Impact: Stocks in individual accounts without a TOD or POD designation usually must pass through probate before they can be distributed to the heirs.
A Joint Account is shared by two or more individuals. There are several types of joint accounts, but the most common is the Joint Tenants with Rights of Survivorship (JTWROS) account.
- JTWROS: In this arrangement, when one owner dies, the ownership of the stocks in the account passes automatically to the surviving owner(s), bypassing the probate process.
- Tenants in Common (TIC): Unlike JTWROS, TIC does not have the right of survivorship. Instead, each tenant owns a specific fraction of the account, which can be passed to a beneficiary of their choosing through their will or estate plan.
Many brokerage accounts allow for a Transfer on Death (TOD) or Payable on Death (POD) beneficiary designation.
- TOD/POD Designation: This is a straightforward way to ensure that the stocks in a brokerage account pass directly to a named beneficiary (or multiple beneficiaries) upon the account holder’s death, avoiding the probate process.
- Changing Beneficiaries: It is important to review and, if necessary, update beneficiaries periodically, especially after major life events like marriage, divorce, or the birth of a child.
Another option for stock ownership is through a trust, a legal entity created to hold and manage assets for the benefit of certain persons or entities.
- Revocable Trusts: The grantor (the person who creates the trust) maintains control of the assets during their lifetime and can change the trust terms at any point. After death, the assets pass directly to the named beneficiaries without going through probate.
- Irrevocable Trusts: Once created, the terms of an irrevocable trust generally cannot be changed. This type of trust can be useful for estate and tax planning.
Some individuals may still hold physical stock certificates. Though they have become less common due to electronic record-keeping, these certificates represent ownership of shares in a company.
- Inheritance of Certificates: Inheriting physical stock certificates usually requires the executor of the estate to transfer ownership to the beneficiary, which might involve the company’s transfer agent and may require a medallion signature guarantee.
Considerations for Inheritance
Understanding the type of ownership and its implications is critical when planning for inheritance. It’s advisable to consult with a financial advisor or estate planning attorney to determine the most effective way to set up stock ownership for your situation and goals.
The Probate Process
Probate is a legal procedure that validates a deceased person’s will and ensures the appropriate distribution of their assets, including stocks if they are not otherwise assigned through beneficiary designations or joint ownership structures. It is a critical concept to understand in the context of inheriting stocks.
What is Probate?
Probate is a court-supervised process designed to sort out the transfer of a person’s property at death. If the deceased owned stocks in an individual account without a TOD (Transfer on Death) or POD (Payable on Death) designation, these stocks will likely have to go through probate.
- Without a Will (Intestate): If a person dies without a will, the probate court will distribute the assets, including stocks, according to state intestacy laws.
- With a Will (Testate): If a person dies with a valid will, the will directs how their assets, including stocks, should be distributed. The probate court ensures that the will is legitimate and oversees the process to ensure the assets are distributed accordingly.
How Does Probate Affect Stocks?
During the probate process, the stocks are essentially frozen, making them temporarily inaccessible to the heirs. Here are some of the potential effects:
- Delay in Access to Stocks: The probate process can take several months or even years, delaying when the beneficiaries can access or sell the inherited stocks.
- Potential Costs: Probate can be expensive. The costs, which may include attorney’s fees, court costs, and executor fees, may reduce the value of the estate, including the value of the inherited stocks.
- Public Process: Probate is a public proceeding, which means the value and beneficiary of the stocks may become part of the public record.
Initiating the Probate Process
After a person’s death, the executor named in the will or a family member typically initiates the probate process by filing a request in the local probate court in the jurisdiction where the deceased person lived. If there is no will, the court will appoint someone (often a family member) to act as the administrator of the deceased’s estate.
- Submitting the Will: The first step is usually to submit the deceased’s will to the probate court to prove its validity.
- Notifying Heirs and Creditors: After initiating probate, the executor or administrator must notify the deceased’s heirs and creditors of the death.
Handling of Stocks in Probate
Here is a typical sequence of steps regarding how stocks are handled during the probate process:
- Inventory of Stocks: The executor or administrator will create an inventory of the deceased’s stock holdings and submit this to the court.
- Appraisal: The court might require an appraisal of the stocks to establish their fair market value at the date of death.
- Paying Debts and Taxes: Before stocks or other assets can be distributed to the heirs, the deceased’s debts and taxes must be paid. This might require selling some of the stocks.
- Distribution of Stocks to Heirs: After debts and taxes are paid, the remaining stocks are distributed to the heirs according to the will or, if there is no will, according to state law.
Avoiding Probate with Stocks
It is possible to set up stock holdings to avoid probate. Common strategies include:
- Joint Ownership with Right of Survivorship: When one joint owner dies, the stocks automatically pass to the surviving owner(s) without going through probate.
- Transfer on Death (TOD) Designations: This allows the stocks in a brokerage account to pass directly to a named beneficiary, bypassing probate.
- Trusts: Placing stocks in a living trust can allow them to pass to heirs outside of the probate process.
Inheriting Stocks and Taxes
When you inherit stocks, it is not just the ownership of those assets that you are acquiring. There is also a set of tax implications that come with this inheritance. Understanding these tax implications can help you make informed decisions about how to manage your inherited stocks.
Step-Up in Basis
One of the primary tax benefits of inheriting stocks is the step-up in basis. This is a critical concept for beneficiaries to understand as it affects the capital gains taxes owed when the inherited stocks are eventually sold.
- Original Cost Basis: The cost basis of a stock is generally the amount originally paid for the stock (plus any reinvested dividends or brokerage fees).
- Step-Up in Basis: When you inherit stocks, your basis is not what the decedent paid for the stocks, but rather the fair market value of the stocks at the time of the decedent’s death.
- Example: If the deceased bought a stock at $20 per share and it is worth $100 per share at their death, the beneficiary’s basis is stepped up to $100 per share.
Tax Implications of Selling Inherited Stocks
After you have inherited stocks and they have received a step-up in basis, here is what you need to know about the tax implications when you decide to sell those stocks:
- Capital Gains Tax: When you sell inherited stocks, you only pay taxes on the gains that occurred after the decedent’s death. This is the difference between the sale price and the stepped-up basis.
- Short-Term vs. Long-Term Capital Gains: If you sell the inherited stocks within a year of the decedent’s death, any profit is considered a short-term capital gain, which is taxed at ordinary income tax rates. If you sell the stocks after one year, the profit is a long-term capital gain, which typically has lower tax rates.
Estate Tax Considerations
- Federal Estate Tax: As of the date of this article, the U.S. imposes a federal estate tax on estates exceeding a certain value. The exact exemption amount can vary from year to year. Stocks included in the deceased’s estate add to the overall value of the estate and could potentially trigger an estate tax if the total estate exceeds the exemption limit.
- State Estate or Inheritance Taxes: Some states impose their own separate estate or inheritance taxes, and the exemption limits can be much lower than the federal limit. The specific rules vary significantly from state to state.
Handling Dividends on Inherited Stocks
If you decide to hold onto the inherited stocks, you will likely receive dividends if the stocks are dividend-paying:
- Tax on Dividends: Dividends you receive from inherited stocks are considered income and must be reported on your tax return. They may be subject to federal income tax at special tax rates, depending on whether they are qualified dividends, and may also be subject to state income taxes.
Special Considerations for Inherited IRAs
If the stocks were held in an Individual Retirement Account (IRA) of the deceased, the rules for inheriting such an account and the associated tax implications can be quite different:
- Required Minimum Distributions (RMDs): Depending on the type of IRA and the age of the original account holder, you may be required to start taking RMDs. These distributions are generally taxable as ordinary income.
- Tax Filing for Inherited IRAs: Inheriting an IRA might require you to file additional tax forms with the IRS, and there could be penalties for missing deadlines.
How to Inherit Stocks
Inheriting stocks involves several key steps that typically begin after the death of the original owner. This process can vary depending on the specifics of the original owner’s estate plan, but the following provides a general guide to help you understand the common steps involved.
Step 1: Locate the Original Stock Certificates or Brokerage Account Information
- Physical Stock Certificates: Some older stock holdings might exist in the form of physical certificates. If this is the case, it’s essential to locate these documents, as they prove ownership.
- Brokerage Accounts: More commonly, stocks are held in a brokerage account. In this case, you will need the account information, which should be found among the deceased’s important papers or with their estate executor.
Step 2: Consult with an Estate Attorney or Financial Advisor
- Legal Advice: Before you take any action, it’s a good idea to consult with an estate attorney or financial advisor who is experienced in estate matters.
- Interpretation of Will or Trust: The attorney can help interpret the will or trust and advise you on your rights and responsibilities as a beneficiary.
Step 3: Provide Required Documentation
You will likely need to provide several forms of documentation to either the brokerage where the stocks are held or to the transfer agent for physical stock certificates. This often includes:
- Death Certificate: A certified copy of the original owner’s death certificate.
- Affidavit of Domicile: A document that confirms the address of the deceased at the time of death.
- Probate Documents: If the stocks are part of an estate going through probate, you may need a copy of the will and/or letters testamentary that grant the executor authority to act.
Step 4: Transfer Ownership
Once you have provided the required documentation and consulted with a professional, you can begin the process of transferring ownership. This step may involve:
- Brokerage Account Transfer: If the stocks are held in a brokerage account, the brokerage firm will have a process in place for transferring the stocks to the beneficiaries. This often involves filling out a transfer of ownership form.
- Physical Stock Certificate Transfer: If you are inheriting physical stock certificates, you will need to work with the stock transfer agent to have new certificates issued in your name.
Step 5: Decide to Sell, Hold, or Diversify
After the stocks have been transferred to your name, you will have several options:
- Sell the Stocks: You may decide to sell the inherited stocks, especially if you are concerned about the associated risks or if you have immediate financial needs.
- Hold the Stocks: If you believe in the long-term potential of the stocks, or they form a meaningful part of your investment strategy, you may choose to hold onto them.
- Diversify the Portfolio: If inheriting the stocks makes your portfolio overly concentrated in one area, you might consider selling some of the inherited stocks and using the proceeds to invest in different assets to diversify your holdings.
Step 6: Consider the Tax Implications
As mentioned in previous sections, inheriting stocks comes with tax implications, including potential capital gains taxes when you sell the stocks. Always consult with a tax professional regarding these issues.
Inheriting stocks can come with its own unique set of circumstances depending on the situation. Here are some special cases to consider, each with its own set of rules and potential complications.
Inheriting Stocks from a Spouse
Inheriting stocks from a spouse is often more straightforward than from other individuals, due to special rules designed to ease the financial transition after a spouse’s passing.
- Unlimited Marital Deduction: In the U.S., there is an unlimited marital deduction that allows the unlimited transfer of assets, including stocks, between spouses without federal estate and gift tax consequences.
- Jointly Owned Stocks: For jointly owned stocks with rights of survivorship, the stocks typically pass automatically to the surviving spouse without the need for probate.
Inheriting Stocks from a Foreign Relative
Inheriting stocks from a relative who was not a resident of your country can come with additional complexities due to differing tax rules and estate laws.
- Foreign Inheritance Tax: Some countries impose their own version of an inheritance tax, which might apply before the assets are transferred to you.
- U.S. Tax Reporting: If you are a U.S. resident, you may have to report the inherited stocks on your U.S. tax return, even if the stocks are not held in a U.S. brokerage account.
Inheriting Stock Options
In some cases, you may inherit not stocks themselves, but options to buy stocks (stock options), which come with their own unique rules.
- Exercise Period: Inherited stock options often have to be exercised (meaning, used to buy stocks) within a certain period after the original owner’s death. This timeframe varies but is generally stipulated in the terms of the options grant.
- Tax Implications: There may be income tax and/or capital gains tax consequences when you exercise inherited stock options. The specific tax implications can vary depending on the type of options and other factors.
Inherited Stocks and Minors
If stocks are left to a minor, special arrangements must be made since minors can’t directly own stocks.
- Custodial Account: One common solution is to establish a custodial account (such as a UGMA or UTMA account in the U.S.) which holds the stocks in the minor’s name, but under the control of an adult custodian until the minor reaches a certain age.
- Trust for Minors: Alternatively, the deceased might have set up a trust that holds the stocks for the benefit of the minor, with distributions controlled by a trustee according to the terms of the trust.
Inheriting Stocks in a Living Trust
When stocks are held in a living trust, they bypass the probate process and are transferred directly to the named beneficiaries.
- Trustee’s Role: The trustee is responsible for managing and distributing the trust’s assets, including stocks, according to the terms of the trust.
- Beneficiary Rights and Taxes: Beneficiaries generally receive a step-up in basis on inherited stocks held in a trust, just like with stocks inherited through other means.
Stocks with Restrictions
In some cases, inherited stocks may come with restrictions on selling or transferring them.
- Restricted Stock Units (RSUs): If you inherit RSUs, these might have specific vesting schedules and selling restrictions.
- Family Business Shares: If you inherit stocks in a family business, there may be agreements in place, such as a buy-sell agreement, that restrict your ability to sell or transfer the stocks.
Inheriting stocks can be a significant financial event that comes with its own set of complexities and emotional weight. At a time when you are likely also dealing with grief, the process can feel overwhelming. However, understanding the mechanics of inheriting stocks and the related tax implications can greatly ease this transition.
Handling the Emotional Aspect
Inheriting stocks from a loved one is not just a financial event; it’s a deeply personal one. You are receiving a portion of someone’s life savings, perhaps accumulated over many years or decades. It can feel like a tangible connection to the person you have lost, and this can add emotional weight to your decisions. Take the time you need to process these emotions and consider speaking with a therapist or counselor if you are struggling.
Be Informed, Be Patient
One of the best things you can do when inheriting stocks is to educate yourself. Familiarize yourself with the terms and concepts involved, consult with professionals, and understand your options and the consequences of each. Remember, you generally do not need to rush these decisions. Give yourself time to make informed choices that align with your financial goals and comfort level.
Consider Your Overall Financial Picture
When you inherit stocks, it’s essential to consider how they fit into your broader financial landscape. Think about your own financial goals, your current portfolio balance, your risk tolerance, and your time horizon for investments. This is an excellent time to revisit your financial plan or work with a financial advisor to create one.
Consult with Professionals
The process of inheriting stocks is filled with legal and financial details that can be difficult to navigate, especially for those unfamiliar with the intricacies of estate and tax law. Working with experienced professionals, such as estate attorneys, tax advisors, and financial planners, can provide invaluable guidance. They can help ensure that you are complying with all legal requirements, taking advantage of any tax-saving opportunities, and making decisions that are in your best interest financially.
Plan for Your Own Future
Inheriting stocks is often a reminder of the importance of planning for our own futures. Use this as an opportunity to consider your own estate plan. Do you have a will? How are your own investment accounts set up? Are the beneficiaries on your accounts current? This is a chance to make sure your own affairs are in order, to hopefully make things simpler and clearer for your own heirs down the line.
Inheriting stocks is more than just a straightforward financial transaction. It is a responsibility and, often, a significant aspect of honoring and continuing a family legacy. By approaching the process with patience, education, and professional guidance, you can navigate the complexities of inheriting stocks with confidence and grace.
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