The occasion of realizing an inheritance is rarely a good one—you’ve most likely lost a parent, grandparent, or other loved one. But the inheritance itself can be reason for celebration, especially if the windfall is an unexpected one.
Two out of three baby boomers will receive an inheritance at some point in their lifetimes, with the estimated median inheritance at $64,000. The wealthiest 10% may realize an average of $1.5 million per household. While not everyone will inherit substantial assets, any inheritance comes with both possibilities and pitfalls. In the following article, we’ll look at some some simple strategies to help you make the most of any inheritance, no matter how big or how small the amount.
Even Before You Inherit Assets
The first and best piece of advice about an anticipated inheritance is to not count on it. Not only can counting on an inheritance negatively affect your overall investment strategy for retirement, there’s always the possibility that your parents or other benefactor will live long into old age, spending down what might have otherwise been a large estate.
With medical bills and long term care costs skyrocketing, what might have seemed like a large windfall can easily be eaten away as your parents consume more of their net wealth by living well into their 90s. And people do change: often parents change their minds about who gets what in their estate. By not counting on any inheritance, you’ll be in a better position financially if things don’t work out like you anticipated.
If you do anticipate a substantial inheritance, remember that the windfall is not without tax implications, and those implications can vary widely from state to state. A bit of research or consultation with a financial planner ahead of time can help you position yourself so that the tax burden is minimized.
Consider the Entire Estate Inheritance
After a nice bottle of champagne to toast your benefactor, the first thing most people should do is calm down. Before you treat yourself to that European vacation or a new sports car, you should realistically assess your new financial position and act accordingly. Many financial planners recommend a ‘cooling off’ period of six months after a big windfall for this purpose.
During this ‘cooling off’ period, you can ‘park’ your liquid assets in short-term bonds or highly rated municipal bonds until you develop a complete financial plan.
Another thing to consider at this time is what to do with the entire estate, including assets you have inherited that are not liquid. When an estate is settled, most people think in terms of real estate and savings or investments. Many are surprised to find that they have inherited a substantial amount in portable luxury assets, like fine jewelry and vintage or luxury watches.
These assets may have sentimental value, but often they are in disrepair or simply not a style that appeals to the new owner. One option is to have the jewelry repaired or redesigned, but many people choose to sell their inherited jewelry items and convert them into cash.
Diamond Estate Jewelry Buyers of La Jolla, California makes selling your inherited jewelry or luxury timepieces a simple process. After providing a few details about your item(s) in an online form, you’ll be contacted by an estate buyer within 24 hours with a preliminary jewelry appraisal, and you can arrange to ship your items for a complete market analysis.
Once the final appraisal is complete, an immediate cash offer will be made, and if accepted, money will be wired to your bank account within 24 hours. The cash you realize from grandma’s antique brooch or your father’s vintage Rolex Submariner can then be considered as part of an overall plan to manage the inheritance.
Examine Your Rainy Day Account
Everyone knows the value of an emergency account, but surprisingly few people actually have one, or one that is adequately funded. A good rule of thumb is to have enough cash on hand for three to six months of living expenses. Even before paying down debt with your inheritance, your emergency account should be fully funded. If not, when the next emergency surfaces, you’re likely to pay for it with credit cards, and the cycle of debt will simply repeat.
Pay Down High Interest Debt
Once your rainy day fund is set, getting out from under high interest debt, like credit cards, car loans, and even student debt, should be the next priority in handling your inheritance. Other debt, particularly mortgages, should be considered based on the interest rate. If you are young and well employed, any mortgage with an interest rate under five percent may not be worth paying off–you’re likely to do better investing that money in a diversified portfolio of stocks and bonds.
If, on the other hand, your mortgage is likely to be a big burden in your upcoming retirement, it might make sense to pay it off. Be sure to consider the tax implications though, as mortgage interest is deductible for taxpayers who itemize.
Consider Your Retirement
If you have not been contributing the maximum amount to your 401(k) or other individual retirement account, you can use your inheritance to help you do that. You can use some of the inherited cash for living expenses, so you can contribute the maximum at work, or consider paying off a car loan with your inherited money and putting your usual monthly payment into your retirement instead of paying off the car loan. Contributing directly to your Roth IRA or workplace retirement fund from your inheritance can help shelter some of your windfall from taxes as well.
If you find that you may have a hard time making your projected retirement income cover your regularly recurring expenses, you could consider using part of your inheritance to set up a fixed annuity. This financial arrangement allows the money you invest to earn a fixed rate of return, and you can arrange to have regular payments made to you throughout your retirement.
For those who are well positioned for retirement, you may want to keep your inheritance in lump sum to draw from when you want it. Rather than functioning as a way to fulfill basic needs, the money can be used like disposable income for for special occasions like entertainment and travel.
If you inherit an Individual Retirement Account, be sure you understand all the implications, as special rules apply. You’ll have to take money out, if it is a traditional IRA, and that cash will count as taxable income. If it is a Roth IRA, the taxes have already been paid, and the payouts are tax-free. If you treat the IRA as an inherited IRA, you can take smaller minimum payouts over the years of your retirement and lessen the tax burden. Be sure to check with a financial planner to confirm all the potential tax consequences.
Honor Your Benefactors and Don’t Forget Your Own Heirs
Most people who receive an inheritance have some sort of emotional attachment to the money, and will often choose to honor their parents or other benefactors in the way they choose to spend it. One way to achieve this might be to splurge on a family vacation as a tribute to lost loved ones. With a large enough inheritance, you might consider investing in a vacation home that can be used by the entire extended family, providing a place for get-away get-togethers that may help keep the family in closer touch.
Another possibility for your inheritance is to consider assisting your children in financing their college education, helping them avoid becoming burdened with excessive student debt. While this option has many benefits, be sure to consider your own financial situation first. Make sure you are properly funding your own retirement, so that you won’t have to rely on your kids at a later date.
If you are particularly well situated for your retirement, you might consider asking your parents to skip you completely, leaving the estate to the grandkids. While this option is best planned well in advance, with the grandchildren named in the will or trust, it can be accomplished after the death of the grandparents.
If you receive an inheritance and want to ‘skip’ a generation, you’ll need to “disclaim” the inherited assets within nine months of your parent’s death. Make sure not to cash any insurance checks, sign any real estate deeds, or re-title retirement accounts. If you do, you will not be able to “disclaim” the inheritance.
A well managed inheritance can prove to be a lasting blessing. If possible, make plans to continue the legacy by considering your own heirs. Although inherited wealth is often squandered, (70% of inherited wealth is lost by the second generation, and 90% is gone by the third), by being a good steward of your inherited nest egg, you should be able to pay a substantial amount forward. Careful and thoughtful investment can allow wealth to build for future generations.