According to Cerulli Associates, between now and 2045, Americans will transfer as much as $72.6 trillion in assets to heirs in what is expected to be the largest wealth transfer in history. Most of that money will transfer from baby boomers to Gen Xers and millennials, meaning that if you are currently under 60, there is a strong chance that an inheritance will come your way at some point.
While the size of any inheritance may vary substantially from person to person, in its most recent Survey of Consumer Finances (SCF) the Federal Reserve estimated that the average inheritance in the U.S. exceeds $110,000 — a significant amount for many Americans, especially when received all at once.
Should you receive such an inheritance, you might be wondering how to best leverage it as a part of your financial plan. Should you invest it, use it to pay down debt or something else?
While the answer to this question depends on your personal financial situation as well as your goals and what is important to you, the following are seven tips to consider after inheriting money.
1. Avoid making emotional decisions.
After you receive an inheritance, take a step back. If you’re dealing with the death of a loved one, focus on processing your grief first.
If you don’t give yourself time to grieve, “you may make emotional financial decisions,” says William Taylor, vice president of business and estate market development for Northwestern Mutual.
Many financial experts recommend waiting six months to a year before touching your inheritance, although the time frame that’s right for you depends on how you process grief.
While you are processing your emotions, you might consider keeping your inheritance in a savings account or a low-risk investment.
2. Understand what you are inheriting.
Inheritances can take several forms, so it’s important to have a clear understanding of what exactly you are inheriting.
Were you left money in the form of cash in a savings account? Perhaps you inherited assets held in a 401(k), IRA, brokerage account or annuity. Are you also inheriting physical assets, such as a home, vehicle or other property?
The type of asset you inherit matters, as there may be tax implications and/or rules governing the size or frequency of distributions from certain types of accounts.
3. Think about your financial goals.
The best use of your inheritance will be that which gets you closest to reaching your personal financial goals. With that in mind, you’ll want to have a clear idea of your goals.
Ask yourself questions like these: What matters most to me in life? What have I always wished I would one day accomplish? An inheritance can be an opportunity to make those goals a reality.
These can be big goals — like buying a house, starting a business or retiring early. They can be small goals — like traveling across the country with your family while they are still young or buying your dream car.
There is no right or wrong here. Your goals are your goals, regardless of what anyone else thinks. Acknowledging and respecting what really matters to you is the first step toward putting your inheritance to good use.
4. Start an emergency fund (or evaluate your existing one).
If you don’t yet have an emergency fund, dedicating a portion of your inheritance to starting one can be a wise decision. A well-stocked emergency fund will give you the peace of mind that comes from knowing you can weather whatever storm life throws at you. It’s also the foundation upon which you can build a robust financial plan.
Most financial experts recommend that your emergency fund hold between three and six months’ worth of expenses, as this is generally enough to see you through common emergencies, including a short stint of unemployment. However, the ideal amount for your emergency fund depends on your own needs and risk tolerance. For some, six to 12 months’ worth of expenses is more appropriate.
If you already have an emergency fund, take this opportunity to revisit it and ensure that it is still funded appropriately given your current financial circumstances. Consider whether your expenses, liabilities and/or risk tolerance have changed, and top up your fund accordingly.
5. Be strategic with debt.
It can be tempting to use such a windfall to pay off debts you may be carrying. If you have high-interest debt, variable-rate loans that are likely to see interest rate increases or other kinds of “bad debt,” that instinct can be a really good idea.
“Paying down credit cards with high interest rates or student loans with higher interest rates is a good first step,” Taylor says.
Taylor does, however, caution against paying off all your debt indiscriminately, as there may be better ways of putting your money to work. If you pay off your mortgage ahead of schedule, for example, you could end up losing tax benefits that come with your loan. Paying off low-interest debts likely also means that you are forfeiting higher potential returns that you could have earned by investing the money.
Before using your inheritance to pay off all your debt, it can help to stop and make sure you are being strategic in your debt repayment efforts.
6. Invest for your future.
Whatever you’re investing for, a well-diversified portfolio that takes into account your risk tolerance and investing timeline is likely the way to go. Resist the urge to try to find the next Amazon or Tesla. Low-cost ETFs and index funds offer a more stable path toward wealth building compared to stock picking.
Nervous about investing such a large sum of money all at once? Consider dollar-cost averaging into your position over time by investing the same amount weekly until you are invested appropriately.
7. Consider your loved one’s legacy.
If you would like to use a portion of your inheritance to honor your loved one, making a charitable gift can be an excellent way of achieving that goal — especially if the individual did not do so for him- or herself.
You might, for instance, make a donation in her name to a charity, cause or organization that meant a lot to him or her. You could also set up a donor-advised fund, start a scholarship at his or her alma mater or sponsor a bench at a park that he or she enjoyed spending time in.
Enlist a professional
If you’re not sure what the best use of your inheritance would be (or you have an idea but simply don’t know how to execute on it), working with a financial professional can help.
Financial advisors start by gaining an understanding of your goals and the assets you inherited. They’ll then use that information to offer advice about how best to manage your inheritance so that it has a lasting impact on your financial goals.
“A good advisor will spend time with you to learn about your hopes and dreams before creating a financial plan to help you get there,” Taylor says.
All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.
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