Receiving an inheritance can bring up a lot of emotions, so don’t rush to make any decisions about how you’ll use the money. Instead, park it somewhere relatively safe—but where it can earn a bit of yield—while you take time to consider your options.
How to best use your newfound wealth will likely come down to whether you receive a modest or substantial sum.
Even a relatively small sum could be life-changing if used effectively. Here are a few ways to help make the most of the funds:
A Modest Inheritance
1. Look for ways to improve your financial situation. For example, do you have an emergency fund set aside that can cover three to six months’ worth of essential living expenses? If not, building it up is a great way to use the funds. Likewise, if you have any high-rate, non-deductible debt (such as credit cards), paying it off can free up income for more productive uses. It’s perfectly acceptable to use some of the funds on something nice for yourself, too, but it’s important to view an inheritance as an opportunity to fortify your finances—for your current and future self.
2. Consult a trusted tax professional. Although the federal government doesn’t tax inheritances, some states do. And depending on the types of assets you inherit, you could also face income or capital gains taxes in the future. For example, if you inherit a retirement account such as an IRA or 401(k), there are numerous rules regarding the timing and size of withdrawals depending on your relationship to the deceased. Working with a tax pro now can help ensure you don’t run afoul of any rules or face an unexpected tax bill later.
3. Put the funds to work for you. Your new inheritance might allow you to save and invest more aggressively toward goals such as buying a home, paying for children’s college tuition, or funding your retirement. Consider your key short-term and long-term objectives and how to best invest your money in the right mix of assets to get you to those goals on time. If you’re not sure where to start, an affordable solution like a robo-advisor could be a good option to consider.
A substantial inheritance
If you inherit a significant windfall, congratulations—you may suddenly have options that never occurred to you, such as retiring early or travelling extensively.
That said, even sizable inheritances can be squandered quickly by financial mismanagement. It’s believed that around 70% of family wealth is lost by the second generation and 90% is gone by the third generation. To make the most of a large amount of new wealth that comes your way, consider these tips:
1. Get a professional, comprehensive financial review. Significant inherited wealth likely calls for an updated investment strategy that reflects your new income, net worth, and tax situation. A trusted professional can help you assess your options, reevaluate your goals, and determine how best to manage your funds.
2. Review your estate plan. As your wealth grows, so does the need for a comprehensive estate plan. Working with an experienced attorney can help ensure your assets pass to your loved ones as intended and in the most tax-efficient manner possible.
3. Reconsider your insurance needs. More wealth could mean that you’ve got more to protect. An insurance review can tell you if you still have the appropriate amount of life, health, and liability insurance—or if your new situation demands additional coverage. A reputable insurance broker can help you think through your options and determine the best coverage for your needs.
4. Consider the advantages of giving to charity. Many people who come into new wealth find a lot of satisfaction from giving some of it away. Donating to charity or a donor-advised fund account can help you put some of your new funds to work supporting favorite charities and causes—and may provide significant tax benefits in the process.
Donald Daigle is an Independent Branch Leader and Financial Consultant at Charles Schwab. He is a graduate of Harvard University with 32 years of investing experience locally in South Jersey. Some content provided here has been compiled from previously published articles authored by various parties at Schwab. Charles Schwab & Co., Inc., Member SIPC.
Employees of Schwab are not estate planning attorneys and cannot offer tax or legal advice, or create and prepare legal documents associated with such plans. Where such advice is necessary or appropriate, please consult a qualified legal or tax advisor