How to Responsibly Handle an Inheritance
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There are plenty of horror stories about sizable inheritances squandered on fast cars and glittering parties. But careful planning and good advice can help people use their good fortune in a way that creates lasting value.
Consider these steps to make sure the money you receive after a loved one dies is used to best advantage.
Keep your own counsel
“Don’t tell anybody,” says Johanna Fox Turner, a certified financial planner with Milestone Financial Planning in Mayfield, Kentucky. “People would just come out of the woodwork wanting you to invest in their good ideas.”
Turner advises talking to a trusted family member or friend who has no expectation of receiving a share of the money. She also favors fee-only financial planners who are paid a straight hourly rate for giving you advice instead of making commissions on the investments they sell you, which can lead to conflicts of interest.
Take your time
“Take a deep breath,” Turner says. “Talk to advisors. Get some perspective.”
She has seen many people who are anxious about letting a significant sum of money sit in a savings account earning very little interest then rush to make investment decisions and make mistakes as a result. She says the potential gains from quick moves are outweighed by the risks of poor choices.
When Jamie Schweser (who later changed his surname to Schwesnedl, after marrying) received $1 million at the age of 26 because his parents sold their business, he spent a lot of time talking to other young people who had been in similar situations. Schweser found them through Resource Generation, a nonprofit organization that helps younger heirs learn about charitable giving. His parents encouraged him to think carefully about how he used the money, but didn’t discourage him from making his own decisions.
“We trust your judgment, but think about it before you do anything,” Schweser remembers his parents telling him.
Make a financial plan
Before you decide whether to use part of the money to pay off debt, to invest for your future or to donate to charity, it’s best to create a long-range financial plan. Then it can become easier to put the money to work.
For many, an inheritance doesn’t top five figures. Yet others may be more fortunate. Among families in the top 5% by wealth, the average inheritance was $1.1 million, according to 2014 information from the Federal Reserve.
No matter how much you inherit, however, having a plan for what to do with it is a good idea.
“People think financial planners are for rich people,” Turner says. “They’re really more suited to middle-income people.”
She estimates that a comprehensive financial road map takes around 5 hours for a qualified planner to help you develop, and the result is a clear set of priorities that enables you to allocate resources efficiently to achieve your goals.
In most cases, inheritances aren’t taxed unless you live in a state that has an estate tax. At the federal level, an estate tax kicks in when the total value tops $5,490,000 for one person this year. When it comes to gifts to family members, taxes are levied after you receive $14,000 in one year from the same person.
Ultimately, Schweser says, he ended up giving away 75% — $750,000 — of his parents’ gift. He kept enough to buy a house and top up a rainy day fund to serve as a cushion against emergencies. Later he went to work for Resource Generation for a time. Now 44, he owns a bookstore with his wife in Minneapolis and receives income from a couple of rental properties.
But even if extreme giving isn’t your priority, modest charitable contributions can be a win-win, both emotionally and from a tax standpoint. Turner says some of her clients feel guilty about taking tax deductions for charitable contributions, but she disagrees.
“Once you have the motivation to give, why not take advantage of what the law allows?” she says.
Depending on the size of an inheritance, it’s not a bad thing to have a little fun. Once you’ve made a financial plan and allocated the money accordingly, there’s something to be said for treating yourself.
For smaller inheritances, Turner recommends using 10% as fun money. If it’s a larger amount, she thinks $10,000 is a nice round number that could be spent on something enjoyable. But she emphasizes that a financial plan is crucial before this decision is made. Otherwise, it’s too easy to buy a nice car. And then another one three years later. And then another.
“If you envision yourself five years from now or 10 years from now and looking back,” Turner says, “do you want to have a lot of used cars?”
No matter how you use the money, you have to live with your decision.
“Do something that will be a story that you like telling,” says Schweser, who still feels good about his decision to give the bulk of his windfall away. “Whatever you do, you’re going to end up telling that story to yourself over and over again, or to other people, so make a good story.”
Turner recommends thinking about the person who left you some of their wealth.
“This is their hard-earned money,” she says. “This is in their memory. You want to honor that memory and be a good steward.”
What does good stewardship look like? That part is up to you.