By Judy Martel
You’ve just received an inheritance you weren’t expecting: Now what? Well, if you’re like most people, the euphoria of sudden wealth lasts only as long as it takes to cash in.
“There are four places the money can go,” said Mark Johnston, senior vice president and financial Advisor advisor with RBC Wealth Management in Dallas. Generally, money is spent, given to family, given to charity or allocated for taxes.
What do most people do? “They spend it,” Johnston said. “The money is frittered away before they even have a chance to consider how it could fund future goals, benefit the next generation or help needy causes.”
About a third of Americans will receive an inheritance in their lifetime, according to research by Jay Zagorsky, an economist and researcher at The Ohio State University. The research shows the average person will lose half of it, almost immediately, through thoughtless spending or bad investments.
That’s a huge waste, considering that in the United States an estimated $6 trillion will be passed down to the next generation (out of a worldwide $16 trillion) over the next 30 years.
“When you get an inheritance, you need to plan ahead and resist the temptation to spend,” said Zagorsky. “I’m not saying you should not spend any of it, but decide ahead of time how much money you’re going to enjoy immediately and how much to put aside.”
Don’t Go It Alone
Getting the most from an inheritance usually requires the assistance of three professionals: a financial advisor, a tax professional and an estate-planning attorney.
The financial advisor’s job is to help you determine how much money you’ll need to fund your current lifestyle and future goals. Only after you’ve nailed that down should you enlist the help of the other two professionals, Johnston recommends.
“In a perfect scenario, the first question the financial advisor asks is, ‘How much of this money do you need?’” he said.
Finding the answer involves considering a number of factors, including age, current financial situation and future needs such as retirement savings or putting kids through college. Then, because there are unknown variables outside your control, the numbers should be run under different scenarios.
“Wealth management planning tools help a person pre-experience what might happen year-to-year for the next 30 years,” Johnston said.
If you believe you can fund your life and still have plenty of excess money, an attorney can help determine the best structure and timeline to pass wealth on to family or a charity. An accounting professional will ensure your wishes are carried out in a tax-efficient manner.
Prioritize Your Goals
It can be overwhelming to plan the best way to use an inheritance, so it helps to tackle the process in a specific order.
First: Get a handle on your current financial situation.
You may think an inheritance of $1 million is all the money in the world, but it might not last very long.
Zagorsky said it’s important for people to look closely at their actual financial situation, not the one they perceive to be true. His research shows the majority of people underestimate their net worth because they haven’t calculated the true value of their assets.
Second: Determine how the inheritance could supplement your lifestyle or accelerate your goals.
An inheritance is meant to enhance your life. You could use it to pay expenses or reduce debt. If you don’t need the money immediately, consider putting it toward your child’s education or boosting your retirement nest egg.
Develop a plan that includes your current spending and assets, said Johnston. Then it’s a math equation to figure out how the inheritance can be used to move up goals like retirement or a property purchase. Or perhaps you have peace of mind knowing you can fully fund higher education for your children or grandchildren.
Just make sure you don’t succumb to the common mistake of leveraging the inheritance, by putting it all toward a down payment for a bigger mortgage, for example. “Don’t adjust your lifestyle upward with leverage,” said Zagorsky.
Third: Calculate how to make it last.
If you need the money to fund future goals, Johnston recommends investing wisely in a mix of stocks and bonds to achieve both growth and stability. Some funds could also be left in cash for immediate income needs. The key is diversification, based on both short- and longer-term needs.
“Putting it all in cash and not investments, for most people is not even an option,” Johnston said. “Figure out what income you’ll need in retirement. Look at Social Security, pensions and existing investment income. Then ask, ‘What do I need from this money to get the income I’ll need?’”
Fourth: Plan your legacy, if there is any excess.
If you want the money to go to charity or family upon your death, you can state your wishes in your will. If the amount of the inheritance pushes you over the current $5.34 million estate tax exemption amount, Johnston recommends setting up an irrevocable trust. It’s a more complex process, which should be handled with the support of an experienced tax professional.
If you plan to donate funds while you’re still alive, a tax expert can take you through the various options based on your current income and the amount you wish to donate.
Don’t Forget To Enjoy It
The payback from solid planning around an inheritance is financial freedom, said Zagorsky.
“Wealth protects you from fluctuations in income,” Zagorsky said. “It protects you from an adverse financial situation and it also helps pay for dream assets.”
A well-formed plan for your newfound wealth will allow you to feel secure about your future and potentially have a little fun, too.
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.
Judy Martel blogs about wealth on Bankrate.com and is the author of The Dilemmas of Family Wealth, published by Bloomberg.
