By Dr. Jim Dahle, WCI FounderReceiving an inheritance is usually a bittersweet event. You miss your loved one, but you rejoice a bit in your new wealth. That’s not always the case, however. Sometimes you may not want an inheritance at all for a number of reasons. The good news is that you are legally allowed to refuse any part of an inheritance, whether it is from a testate death (where there was a will) or an intestate one (where the state follows its own intestate rules).
This is a fairly rare event. Most people love most inheritances. They receive money, valuable assets, or sentimental items. What’s not to like? Well, imagine your great aunt left you her timeshare. It is in a terrible location that you never want to visit. It has an onerous annual fee. There is no real market for selling it. It has no value to you, and it’d be a significant liability to your time and money. You just don’t want the stupid thing. So, you refuse (disclaim) it. Voila! It’s not yours and never was. It now goes to the next beneficiary in line in the will, trust, or intestate succession. If they all refuse it, the state is stuck with it.
What Does It Mean to Disclaim an Inheritance?
Sometimes referred to as signing over an inheritance or refusing an inheritance, disclaiming is a legal process where it is as though you never received the inheritance at all. The trustee or executor simply moves along to the next heir in line and offers the inheritance to them. This is different from taking an inheritance and then giving it to someone else. In this case, you are not responsible for any liabilities associated with the item, never benefit from owning it, and do not control who it goes to after you disclaim the inheritance. Legally, disclaiming is as though you predeceased the deceased. In many wills and in most intestate situations, the distribution then occurs “per stirpes,” meaning your share goes to your kids rather than being divided among the other heirs.
More information here:
The Worst Financial Gifts to Give Your Kids
Economic Outpatient Care and the Aspiring Millionaire Next Door
How to Disclaim an Inheritance
This is all governed by state-specific law, so make sure you look up the laws in your state. But in general, a proper disclaimer has several key aspects:
- It must be done within nine months of vesting (i.e. the death of the person leaving it to you) or within nine months of turning 21, whichever is later.
- It must be done in writing (and often must be notarized or witnessed).
- It must be irrevocable.
- You can not receive any personal benefit from the property before disclaiming.
- You can not receive anything else in exchange for your disclaimer.
- You cannot control who the inheritance goes to.
When to Disclaim an Inheritance
Nine months—or nine months from the time you turn 21. It does not have to be done immediately. However, you cannot use the property or money for nine months and then disclaim it. You cannot put it off forever either. If you don’t disclaim within nine months, you’re stuck with the inheritance and all the consequences of owning it.
More information here:
When to Give Inheritance Money to Your Kid?
10 Reasons to Consider Disclaiming an Inheritance
Now that we’ve discussed the basics, let’s talk about WHY someone might want to disclaim an inheritance. In most circumstances, you can accept the inheritance; use it yourself for a few months, years, or decades; and then give it to someone else during your life or after your death. Why not just do that?
#1 Avoid Unwanted Property
Maybe you just don’t want your grandma’s collection of 8,000 garden gnomes. Or her timeshare. Or her falling-down, packrat home that will cost you more to empty and bulldoze than it would be worth to sell.
#2 You Want the Next Heir in Line to Get the Property Instead
Sometimes it isn’t that the property has no value, you just think someone else that you care about could use it more. And that someone else just happens to be next in line as beneficiary. That’s often your child. You’re essentially telling them, “I don’t want grandma’s house and I know you do, so I’m going to make it so you get it instead.”
#3 Avoid Creditors
Let’s say you have an outstanding judgment against you, but the creditors can’t actually get anything because your only assets are protected from them by ERISA, homesteading, or LLC law. However, if you were to receive the inheritance, that would then become available to your creditors. By disclaiming it, you can stiff the creditor. Thus, disclaimers are not only an estate planning technique but also an asset protection technique.
So long as you would prefer the next heir to get the asset rather than your creditor, this is a great move. Like most asset protection moves, it’s not bulletproof. It can’t be used to get out of a state or federal tax bill. Plus, all asset protection laws are state-specific, and those laws can have slight variations.
#4 Get the Good Stuff
As an heir, you’re allowed to be choosy. Barring some specific statement in the will or trust, you can just refuse part of an inheritance. Maybe Aunt Martha and Uncle George left you their cats and their house, thinking you’d take care of their cats in their old house. If they didn’t write that will carefully, you could take the house and disclaim the cats if you wanted.
#5 Gifting
Disclaiming an inheritance is an extremely tax-efficient way to gift. Neither the annual gift exclusion nor the estate tax exemption limit applies to disclaimed inheritances. As long as you WANT to give this valuable asset to the next beneficiary in line, there is usually no better way than just disclaiming it.
#6 Correcting Gifts
Sometimes the will was poorly drafted or circumstances changed after it was drafted. You know that Grandpa meant for the farm to go to Uncle Cody, not you. You know if you take it as stipulated by the will, Cody will never speak to you again. You disclaim it, and it goes to the next person in line. As long as everyone in line between you and Uncle Cody also disclaims it, he’ll get it as originally intended and as is best for family relations.
This can be a good way to “even up” inheritances that were originally intended to be even but didn’t turn out that way in the end. Maybe you were supposed to get the cabin and your sister was supposed to get the lakehouse, but now the cabin is only worth $100,000 and the lakehouse is worth $250,000. Your sister can disclaim part of the lakehouse to make it right. Or maybe she really wants the cabin and “trades” you half of the lakehouse for it using joint disclaimers.
#7 Changing the Entity
Savvy estate plans can be written up that can provide additional asset protection options. For example, your spouse can be the first beneficiary, and the second beneficiary can be a trust that holds the assets on your spouse’s behalf. By disclaiming the inheritance, your spouse gets additional future asset protection.
#8 Allow Qualification for Government Benefits
Some government benefits—like student loans, Medicaid, and welfare—can be dependent on your level of wealth. If you receive a big inheritance, you may no longer qualify for those benefits so it can make sense to disclaim them. They’ll often still be “in the family” but won’t affect qualification.
#9 Lower Income Taxes
Sometimes you don’t need the money and would rather NOT pay taxes on it at your high tax rate. Consider a doc in the top tax bracket whose parent dies. The doc’s kids are in a low tax bracket, and the chief asset being passed on is a traditional IRA. If the doc takes the Required Minimum Distributions, they’ll be highly taxed. If the kids take them, they’ll be lightly taxed. Disclaiming can save a lot of income tax in this situation. Sometimes a younger person can also stretch out payments of an inherited IRA or annuity for a longer period of time. Income-producing assets, such as rental property or small businesses, may also be better to disclaim to a family member with a lower taxable income.
#10 Lower Estate/Gift Taxes
Perhaps the biggest reason why wealthy people might disclaim an inheritance is to avoid having the inherited assets in their estate. If they’ve already got an estate tax problem, why make it worse? Why not disclaim and keep those assets out of the estate?
The Generation-Skipping Tax
Don’t forget that you can’t just disclaim a gift to avoid paying the equivalent of estate tax at every generation. When assets are left to someone who is at least 37 1/2 years younger than the decedent, the equivalent of two layers of estate tax is charged via the Generation-Skipping Transfer Tax (GSTT). While this complex tax cannot be fully explored in this particular post, it is important to know how it works if saving estate tax is the goal of disclaiming an inheritance. It can still make sense for a wealthy heir to disclaim part or all of an inheritance to save on estate taxes and/or the GSTT, but it’s often only if the middle generation is the wealthiest of the three.
More information here:
What You Need to Know About the Generation-Skipping Transfer Tax (GSTT)
Consider How Disclaiming Affects the Next Heir
One last word of caution. When disclaiming, don’t just think about yourself. Also consider the situation of who the next heir in line will be. The problem you’re trying to avoid may be pretty minor compared to the problem caused for the next recipient. The best thing for the family overall may very well be for you to actually take the inheritance.
Disclaiming part or all of an inheritance can be a useful and powerful potential and actual tool in an estate plan. Wield it carefully to maximize the financial situation of all involved.
What do you think? Have you disclaimed an inheritance? Why or why not? Do you plan to?
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