Many of us, but actually not most of us, will receive an inheritance at some point in our lives. And about one in three of us will have spent/lost that inheritance within two years. If you inherit $10,000 this may not be a big deal. But if you inherit $100,000 or even $1,000,000, you may regret parting with it so quickly. So what should you do if someone leaves you a financial gift?
I recommend to my clients that we meet and make decisions together about what to do with the inheritance. Since I’m a fee-only advisor, this assures independent financial advice with no fear of a conflict of interest. If you have some other form of advisor (broker, banker, friend, etc.), be sure that their advice benefits you and not them. In our meetings on this, we’ll find the best way forward for your own situation. However, there are some general principles that you can use to think about things on your own.
The first rule of thumb is to take a breath before you do anything. This is particularly true if you were close to the giver and are therefore are experiencing grief. For example, if this is your spouse, you may wish to read my earlier article called The Role of a Financial Advisor When a Spouse Dies. However, significant grief can be felt in other deaths such as a parent, grandparent or a very close friend. The thing to note is that our decision-making capabilities are impaired when we’re experiencing grief. So, place your inheritance in a money market account or a similar short-term investment until the grief has diminished. Even if you’re not experiencing grief, this is a great strategy while you figure out what to do.
Second, it’s always good to consider taxes so that you don’t spend money that you don’t actually have. You may hear of estate taxes, but they only exist on very large estates and are paid by the estate itself – not by you. The taxes we need to consider here are called inheritance taxes. Fortunately for us, there are no federal taxes on inheritance and in Colorado, there are no state taxes. However, if the inheritance is in an IRA account, there are most likely taxes on distributions.
There are many options for how to use unexpected income. These options include building/enlarging your rainy-day fund, paying off debt (including credit card debt, mortgage debt, student loan debt and so on), investing for retirement, investing for your children’s education, making a charitable contribution, investing for your legacy (passing it on) and, yes, having some fun.
There are often some special considerations depending on the kind of assets you inherit. Naturally a house, valuable jewelry, a car or other specific assets will have their own considerations. Even financial assets can require some careful consideration. For example, if you inherit a tax-qualified asset such as an IRA, several distribution methods are available.
As you can see, there are a number of important decisions to make if you receive an inheritance. We’d be happy discuss your options in a no-charge, no-obligation initial meeting. Just visit our website or give us a call at 970.419.8212 to learn more.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.