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What to Do With an Inheritance


2What to Do With an Inheritance

Receiving an inheritance from a family member can create a large windfall of cash, and with it, new financial opportunities. What you do with the money will depend on the size of the inheritance, your financial situation and level of experience managing investments. But having a defined plan for the inheritance is vital. A frequently cited study conducted by The Williams Group of San Clemente, California, found that 70% of wealthy families lose their fortune by the second generation and 90% squander it by the third generation. A financial advisor can help you make the most of your inheritance by taking stock of your financial circumstances and creating a plan for the future.

Are You Ready to Invest?

The first question to ask yourself upon receiving an inheritance is whether or not you’re truly ready to invest. If you have debt, especially high-interest loans or credit card bills, you probably aren’t in position to begin investing.

While it may not be as exciting as picking mutual funds, exchange-traded funds or individual stocks, paying off debt is a logical and responsible way to use the money. Think of it as an investment in your future. By wiping out your student loan or credit card debt, you’ll free up hundreds, if not thousands, of dollars each month to use in some other way.

If you’re already debt-free or have money left over after paying off your debt, it’s time to examine your savings. Experts recommend having three to six months’ worth of expenses saved in an emergency fund. Not only is it a prudent financial move, but building an emergency fund can give you the sense of security and confidence you need to start investing. You’ll know that no matter what happens to the money you invest in the future, you have a security blanket in the form of your emergency fund.

Save It for Retirement

Like paying off debt or building an emergency fund, putting your inheritance toward retirement may not get your juices flowing, but it’s a sound investment. A recent Schwab Retirement Plan Services survey found that 401(k) plan participants across the country now believe they must save $1.9 million for retirement. Yet, one in four Americans have nothing at all saved for retirement, according to a PwC report.

If you choose to save the money for retirement, you can do so in several ways. If you have an employer-sponsored retirement plan, like a 401(k) or 403(b), you won’t be able to directly invest the inherited money into your retirement account. Instead, you can use the inheritance to cover living expenses while increasing  amount of money you contribute to your retirement account from your paycheck every pay cycle.

For example, say you inherited $50,000. You could invest the money in retirement accounts over the course of two years by maxing out your annual 401(k) contributions and adding the rest to a Roth IRA each year.

Open a Brokerage Account

What to Do With an Inheritance

While 401(k)s and IRAs are great vehicles for saving for retirement, they come with significant limitations. If you wish to withdraw your money from a retirement account (except Roth IRAs) before age 59.5, you will incur a hefty 10% penalty on top of income taxes.

If you have a more intermediate or short term goal for the money, opening a brokerage account and investing the money yourself will provide flexibility that a 401(k) or IRA will not. You can open an account with companies like Fidelity or TD Ameritrade, and then buy stocks, bonds, mutual funds, exchange-traded funds and other securities.

If you’re just starting out, consider investing in index funds. These low-cost, no-hassle investment vehicles track a market index like the S&P 500 or Dow Jones Industrial Average. Instead of picking and choosing between different stocks or mutual funds, you can invest in an index fund and get wide exposure to an entire market.

Hire a Financial Advisor

If you’re unsure what to do with your inheritance or simply want an unbiased partner to help you create a plan for the money, hiring a financial advisor is likely your best option. A fiduciary advisor who puts your best interests first can help you assess your financial situation and find the best use for your money.

Assuming you wish to invest the windfall, a financial advisor can create a portfolio of mutual funds, ETFs, individual equities, fixed-income securities and alternative investments that aligns with your risk tolerance and time horizon.

Then again, working with a professional comes at a cost. The fee that many investment advisors charge for asset management is often based on a percentage of your assets under management (AUM). The industry standard for asset-based fees is typically 1%, meaning if you have $100,000 under your advisor’s management, you’ll pay $1,000 in annual fees. Advisors may also charge separate, fixed fees for standalone financial planning services, but the fee structures will vary.

Buy Real Estate

Using a portion of your inheritance (or all of it) to buy real estate can also be a good use of the money. Like the stock market, the home values have steadily increased over the years. According to Census Bureau data compiled by the Federal Reserve Bank of St. Louis, the median sales price of homes in the U.S. has grown by nearly 1,400% in the last 50 years (not adjusted for inflation). Investing in real estate is also viewed as an effective way to hedge against inflation.

But if you already own a home, consider using the inheritance money to pay off your existing mortgage. The benefits of this strategy are twofold. First, the money will instantly convert into home equity. If you choose to sell your home, you won’t have to pay back the bank or mortgage lender. Second, like paying off your high-interest debt, wiping out your mortgage payments will free up a considerable amount of cash each month to invest elsewhere.

Bottom Line

What to Do With an Inheritance

Inheriting money or property can have a profound impact on your financial future, but making smart choices with the money is paramount. Before investing your inheritance, be sure to pay off all debt and establish an emergency fund. From there, you can invest the money in stocks or mutual funds through a brokerage account, buy property or save for retirement. A financial advisor can play a important role in this process, provide valuable advice and manage these investments on your behalf.

Tips for Managing Your Inheritance

  • A financial advisor can be a valuable resource to help you handle a large inheritance. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • While most states don’t collect inheritance taxes, you may owe taxes on future capital gains you make from an inheritance. SmartAsset’s free capital gains tax calculator can help you determine how much you’ll potentially owe in capital gains tax upon selling assets like stocks or mutual funds.

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