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An inheritance is a meaningful financial gift.
That being said, it can often be unexpected, and some people may struggle to make the most of their newfound wealth.
Should you pay off debt? Save it all for retirement? Help out a friend or relative? Splurge on something fancy?
Before you read too much further, here's a powerful cheat sheet on thirty-five key considerations you should consider with sudden wealth. It's the same checklist we actually use with clients.
But even with all of that information, decision fatigue can quickly set in, leaving people with no clue what to do next. That's where we come in.
Here are some ideas of what you can do to set yourself up for the future with your new inheritance.
You Don't Have To Take Action Right Away
An inheritance is almost always connected with loss, which can add to the complexity of the situation. If you find yourself in such circumstances, take some time to process the event and your feelings before touching the money. Don’t rush to any decisions or put pressure on yourself to act.
Emotions, especially intense grief, can cloud decision-making and overpower what would otherwise be rational and logical thoughts leading to poor outcomes. There's no benefit to rushing the decision.
The money will still be there when you aren’t reeling from the loss.
The Inheritance Should Support Your Financial Goals
As you start to think about the steps you’ll take, remember that money has a purpose.
Your loved one left you this gift to help you financially. Rather than thinking about the money itself, take time to consider your values, goals, and priorities (financial or otherwise) and how an inheritance could help you accomplish those things. This will help you frame your decision properly with a focus on the outcome.
Some examples of goals you may want to use this money for include retiring the way you want, paying off your debt, or purchasing a new home.
Here is a master list of goals to help generate more ideas on what’s possible
Spend some time in thought, then meet with your advisor to review your options and identify the most appropriate course of action and map out a plan to implement it.
Know What You Inherited
Something else to consider is that not all inheritances are created equal. Knowing what you inherited will help you and your advisor create a plan specific to the type of assets you were given.
Let's review some common inheritance vehicles and the key considerations of each type.
Cash: This has the most flexibility. There are generally no tax consequences or valuations to consider.
Investment account: These include retirement accounts like 401ks and IRAs, but could also be standard taxable brokerage accounts. This type of inheritance can be tricky because you need to consider how the money is invested, as well as the tax consequences of selling investments or pulling money out of the account. In the case of retirement accounts, you also need to plan for the required distribution timeline specific to inherited accounts.
Real Estate: Real estate can be handled in a number of different ways. For example, if it’s your family home. you may not think of it as an investment at all. Rental property may not have the same sentimental value.
Depending on what you inherit and your situation you may either want to live in the house, rent it out, or sell it. There are different tax and financial implications with each of these scenarios.
Personal possessions: This can be anything from a car to jewelry, to an heirloom that has been in the family for generations. As with real estate, you may or may not personally value them, and will have to consider whether you’ll keep or sell them.
A Quick Note On Estate And Inheritance Taxes
Many people consider tax laws to be somewhat complicated or confusing, and perhaps even more so in the case of an inheritance.
To be clear, you are not taxed for the simple act of receiving an inheritance of $1 million. That’s true at both the federal level and in the state of Virginia. There is a federal estate tax (VA doesn’t have a state-level estate tax but other states do), but that will be handled before you receive an inheritance.
So, while you aren’t taxed for receiving an inheritance, you may be taxed after the fact depending on what you do with it. That’s partly why it’s so important to plan ahead before you start making decisions. You don’t want to watch the value of your inheritance erode from taxes that you could have avoided or reduced.
Here’s a common example to show you what we mean.
Assume you inherit an IRA. You won’t owe any taxes for receiving it. However, you will owe income taxes on any distributions you take. Inherited IRA rules generally require that you take the money out of the account within ten years… so do you take it out all at once? Spread it out over ten years? Wait the full ten years and then take it all out in the tenth year?
Your decision will make a big difference in the amount of money you will owe in taxes.
You Inherited $1 Million In Cash: A Case Study
Let’s take a look at a 50-year-old couple - Dan and Darla. Dan's father passed, leaving them to be the beneficiaries of a $1 million life insurance policy.
Since their largest goal is funding retirement, they decided to invest 40% of the insurance payout into a balanced portfolio of stocks and bonds for a long-term horizon of 10+ years. This increases their progress and may even help them reach their goal more quickly.
Next, they kept 20% in less aggressive investments and strengthened their cash reserves so that their short to medium-term goals are less affected by any potential volatility over the next 5-7 years, reducing their overall risk.
Giving is important to Dan and Darla, so they plan to donate anywhere between 5-10% of their inheritance to charity or help support other family members who may have specific needs like home repairs, caring for a newborn, or sending children to college.
Recognizing that they don’t have to save everything, they decided to spend about 10% on an international trip they’ve always hoped to do someday and renovate their home to a more modern kitchen and appliances.
For now, they’ll wait to decide on what to do with the rest of their inheritance. This gives them a little more time and flexibility to make sure they are really putting it toward the best use.
Planning Ahead
The case study we included is just one example of how you might allocate an inheritance. Lastly, don’t forget to account for taxes and dedicate a percentage toward paying them.
Whether you’re reading this because you recently received an inheritance, or because you believe you may receive one in the future, you’ll want to get started on devising a plan for it.
Click here to schedule a free consultation with one of our experts and set your plan in motion!
Author: Mark Fonville, CFP®
Mark is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors specializing in helping individuals aged 50 plus plan, invest, and enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosures: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place.
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