Receiving an inheritance can be a great financial opportunity. However, it can also be a very emotional time, as it involves the loss of someone close to you. Additionally, there are many potential financial challenges and pitfalls that come with the inheritance.
According to an October 2019 study, over the next decade, millennials are expected to inherit over $68 trillion from their baby boomer parents. With this massive transfer of wealth, it’s important to have a plan to ensure the long-term benefits of the inheritance. You need to understand such things as inheritance taxes and managing your newfound wealth, as well as finding a trusted advisor on how to avoid spending too much, too fast.
This article will help you understand how you can benefit from your inheritance. The following is a list of do’s and don’ts, which can help you decide what to do with the money and hopefully create a lasting legacy.
What to do when you get an inheritance
Here are tips on the best things to do when you receive an inheritance from a family member or friend:
- Do ... nothing. At first, don’t do anything with the money, other than put it in a safe and secure place. Use risk-free financial vehicles such as a short-term certificate of deposit (CD), a savings account or a money market account. Even though these pay minimal interest, you get the benefits of essentially risk-free investments. You can then give yourself a little time to adjust to the idea of the inheritance, while you research your options and decide how best to proceed. Otherwise, you may do what lots of heirs do: get excited and spend a big chunk of it quickly, often ending up with little to show for it.
- Find a trusted financial advisor. Ask for referrals from friends, family members and colleagues to develop a list of advisors to contact. A financial advisor can guide you through the process of consolidating and re-titling assets, prioritizing goals, and managing your inherited assets. If there’s a sizable inheritance, look for both a trusted estate attorney and an accountant as part of your team.
- Account for taxes. When you make plans for how to use your inheritance, consider that you will likely have to pay taxes, which are usually paid by the beneficiary. Whether or not the money you inherit will be subject to an inheritance tax depends on the relative, the size of their estate, and the state you live in. You don’t want to spend or invest all the money and be left with a potentially sizable tax bill.
- Pay off debts – don’t incur them. Nothing destroys wealth more than having debt, such as high-interest credit cards. Using an inheritance to pay off debt frees up your future cash flow, reduces your expenses, and saves you the money that would otherwise go toward paying interest on your debts. Plus, paying these off raises your credit score.
- Create an emergency fund if you don’t already have one. Aside from the financial stability, an emergency fund covers you in the event of an unexpected financial blow. Having easily accessible savings provides peace of mind if you lose your job, become too ill to work, or have to cover any major unexpected expenses.
- Save for a down payment on a home or for retirement. Depending on your stage in life, having funds available can provide a vehicle to invest and build a future in a home. Long term, putting money from your inheritance into your retirement account is a good step toward a solid future. Either way, or a combination of the two, is an effective and responsible use of an inheritance. Your trusted financial advisor can help provide essential insight and direction that is best for you.
- Contribute to a college fund for your children if you have them. Contributing to your child’s education is a smart way to spend your inheritance and builds upon the legacy of those you got the inheritance from. Consider investing through a qualified 529 plan.
- Learn to say NO. Once people learn that you have come into an inheritance, there will be plenty of long-lost family members and friends, with needs, “opportunities,” and charities that will come to you for money. This is your and your family’s financial well-being; don’t risk it to be the “hero.” Learn how to establish boundaries with family and friends, and try to stay away from scammers.
- Indulge yourself (a little). Once you have done all the right things by paying off debt, investing, and saving for the future, take a small percentage and splurge. Set aside a certain amount of money that you can use to splurge on whatever will bring you joy. Just don’t break the bank. The goal is to enjoy an indulgence that will fulfill the need to spend and hopefully keep you from some of the out-of-control spending that can derail your financial future.
What not to do when you get an inheritance
Avoid these common pitfalls after you inherit money:
- Let the “new money” burn a hole in your pocket. When you inherit money, you might feel the sudden urge to make big purchases that you always wanted to make but never could. It is okay to buy a new car or get a bigger house if your inheritance is big enough and (most importantly) if you need it. Think before spending – consider the sacrifice and hard work that likely went into earning the money you’ve been given.
- Expect an inheritance to solve financial problems. This is a bad idea because in many cases most people will not receive a substantial sum – not enough to pay for retirement and/or a lavish lifestyle. In many cases, it could be substantially less than expected or left to someone else. At best, even a small inheritance can ease financial burdens and help you save more money, but in most situations, it doesn’t provide the ability to quit your job or change your lifestyle.
- Tell people the details of the inheritance. If you receive a sizable inheritance, human nature dictates that it can breed jealousy and contempt among family/friends. You may also find that others now expect you to foot the bill when you’re out with friends or going on a trip. Be generous with your time, and help those truly in need. But in general, the best bet is to be humble.
- Drastically increase your spending. Let your inheritance money grow for your future. If you start living a lavish lifestyle with your new money, it’s hard to stop if your spending gets out of control.
- Fail to seek professional help. Navigating new wealth is complicated, and mistakes happen when you buy products, make investments, and cash out annuities without fully understanding the consequences of those actions. Hire a competent financial advisor who can help prioritize savings and debt payments and minimize tax liability. Some companies will now target you to market their products because your assets have increased. Many offer complex financial vehicles that come with high fees, and many times high risk. Remember the old adage “If something seems too good to be true – it is too good to be true.” A trusted advisor will be able to help you navigate the options and help you secure the long-term success of your inheritance.
Receiving an inheritance can come with the full gamut of emotions. Understand and honor the sacrifice and commitment the person made over the years to be able to give you the inheritance. With a good plan, and the guidance of a trusted team, you can ensure a brighter financial future for yourself and your family.