Quick Guide: Smart Inheritance Management
Receiving an inheritance is a life-changing event that requires careful planning to avoid the common “windfall effect.” Financial experts recommend a balanced approach: first, eliminate high-interest debt to free up cash flow; second, bolster retirement savings (IRAs or 401ks) to secure your future; and finally, set aside a modest portion for discretionary spending. Having a clear plan prevents the common pitfall of squandering assets before they can build long-term wealth.
5 Steps to Protect Your Windfall:
- Inventory Goals: List short-term needs (repairs, bills) and long-term goals (retirement, college).
- Pay Off Debt: Eliminating revolving credit card debt often provides a higher “return” than any savings account.
- Max Retirement: Use funds to contribute the maximum allowed to tax-advantaged accounts.
- Avoid “Extra” Thinking: Don’t treat an inheritance as “free money”; evaluate purchases as if you had to save for them out of your paycheck.
- Consult a Professional: A financial planner can provide a roadmap to ensure the money lasts for generations.
Receiving an inheritance can be a confusing and stressful experience. What’s the right thing to do? Should I make that big purchase I’d been thinking about? Should I save it? If so, where and how? As many who have received a windfall can attest, without proper planning, even a significant inheritance can be squandered in just a few years.
Here are five strategic steps to ensure your inheritance serves your financial health for years to come:
1. Take a Financial Inventory
Good planning starts by answering two questions: What do you want, and what do you have? Make a comprehensive list of your financial objectives, including short-term goals like home repairs and long-term goals like retirement or funding a child’s education. Compare this against your current assets and liabilities (what you owe).
2. Eliminate Revolving Debt
While not as exciting as a luxury purchase, paying off debt is often the smartest move. It frees up monthly cash flow, saves you thousands in compounding interest, and improves your credit score. Using an inheritance advance to pay off high-interest credit cards today can actually save you more money than waiting 18 months for probate to end.
3. Maximize Retirement Contributions
The average American in their 50s has significantly less than the $1 million+ typically recommended for a comfortable retirement. If your inheritance allows it, maximize your contributions to a 401(k) or IRA. This not only builds your nest egg but can also provide significant tax advantages in the year you receive the funds.
4. The Psychology of “Found Money”
Studies show that people are more willing to overspend when using “found money” or credit cards compared to earned cash. This is because it diminishes the “pain” associated with spending. To combat this, ask yourself: “Would I still buy this if I had to save for it for six months out of my regular salary?” If the answer is no, it’s probably a discretionary purchase you should skip.
5. Build a Long-Term Roadmap
Whether you manage the funds yourself or hire a financial planner, having a written plan is the best way to prevent yourself from looking back in five years and asking, “Where did the money go?” A plan provides the discipline needed to balance enjoying your inheritance today with securing your lifestyle tomorrow.
Frequently Asked Questions
It depends on your interest rate. If your mortgage rate is very low (e.g., 3%), you might earn more by investing the inheritance in a diversified portfolio. However, if you value the peace of mind of being debt-free, paying off the mortgage is a safe and rewarding choice.
In the United States, inheritances are generally not considered income for federal tax purposes. However, you may owe taxes on any income generated by the inherited assets (like interest or dividends) after you receive them.
Yes. If you are a beneficiary of an estate in probate, you can use an inheritance advance to receive a portion of your funds in a matter of days. This allows you to stop the “bleeding” of high-interest debt immediately rather than waiting months for the court to conclude.