Be smart with inheritance money

According to the AARP, one fifth of all baby boomer households have received an inheritance and the average inheritance is $64,000. Another 15% are expected to receive an inheritance in the future.

While inheritances are usually financial blessings, financial advisors say that many recipients don’t manage them properly. A study by Ohio State University’s Center for Human Resource Research found that adults who receive inheritances typically only save half of it.

I recently wrote an article for about smart ways to spend your inheritance. Susan Bradley, CFP and founder of the Sudden Money Institute, said that whether it’s an inheritance, lottery winnings or a settlement, many people blow money that they didn’t have to work for.

“It’s likely a once-in-a-lifetime opportunity to make your life more secure and enjoy a little more financial freedom. You have to use it wisely because once it’s gone, it’s gone,” she said.

The first thing you should do when you receive an inheritance is sit on it a while.

Bill Hammer, a Certified Financial Planner and co-founder of the Hammer Wealth Group, said age isn’t always a factor. He has seen 50-year-olds “make 20-year-old decisions” when they receive large sums of money from inheritances. Hammer said the first step to avoiding making bad knee-jerk decisions is to simply sit on the money for a few months.

“Most people will have that money spent in their mind before it even hits the account. Don’t do anything with it initially. It’s a psychological thing. People make better decisions when they wait a few months,” said Hammer.

Bradley said because people don’t have to work and sweat for inheritance money, they often view it as easy money and are more inclined to blow it.

“It’s likely a once-in-a-lifetime opportunity to make your life more secure and enjoy a little more financial freedom. You have to use it wisely because once it’s gone, it’s gone,” she said.

Next, consider paying down any high interest debt you may have.

Mari Adam, President of Adam Financial Associates in Boca Raton, Fla., recommends you first put the money in a safe interest-bearing FDIC-insured account until you’ve had time to plan how you’re going to allocate and use the money. Although you’d be taking on some risk, another option would be to park it in a brokerage account and invest in some dividend-paying Blue Chip stocks.

If you’re struggling with high-interest debt such as credit card debt, one of your first moves should be to allocate at least a part of your inheritance to pay it down. Carrying a $5,000 credit card balance at a 15% interest rate can cost you up to $750 per year in interest. If you inherited $20,000 and paid off that balance, you’d be saving yourself the interest every year.

“Having less debt is always better. When you pay down debt you’re getting a guaranteed return on your investment,” said Hammer.

You should also consider paying down any high-interest student loan debt or a car loan, assuming the rate is above 6%.

While it might be tempting to pay off a mortgage, Hammer said it may not be the best use of the funds, especially if you’re paying 4% or less on a fixed loan. That’s because you may be able to earn more on your sum by investing it.

“If the spread is very close, you should just pay down the debt. But if you can make 8% on your money and your mortgage is at 4%, you might want to hold off on paying it down,” he said.

If you don’t have high interest debt, or if you’ve got some money left over after paying it down, save for your retirement and your child’s education.

After paying down debt, a wise use of inheritance funds would be to put it towards your own retirement or your child’s education fund. Because of the long-term power of compounding, a large supplemental contribution can have a big impact later down the line. Bradley said while saving consistently over time is the key to having enough for retirement, a lump sum surge can make things so much easier.

“If you’re typically putting away $100 per month towards your child’s education fund and inherit $20,000 and put $10,000 towards that, you have advanced years in those savings,” she said.

Let’s say you were to take $5,000 of inheritance money and put it in a Roth IRA. If that were to grow at a modest 6%, it would be worth over $16,000 in twenty years and more than $28,000 in thirty years.

Hammer said that while it’s critical to save for your child’s education, it should come after retirement funding. That’s because while you can always use Roth IRA retirement funds to put towards education, you can’t use education funds to cover yourself in retirement. If you need to pull money out of an ESA or 529 plan, you could be hit with a 10% penalty and taxes. Contributions to a Roth IRA can be withdrawn at any time for any reason without penalty.

“If you’re not sure, I’d err on the side of retirement and start putting away money there,” said Hammer.

Finally, if you’re determined to have a little fund, consider investing it and splurging off a small portion of the earnings.

There’s nothing necessarily wrong with enjoying and playing with some of your inheritance money if you’ve taken care of high-interest debt and other financial priorities. If the amount is large enough, you could invest most of the money then use a portion of your earnings for fun.

For instance, if you were to inherit $200,000 and could earn a 5% return on it, that would generate $10,000 per year in income. It’s not enough to quit your job but it could certainly provide a little extra spending money during the year.

Better yet, reinvest half of that and enjoy an extra $5,000 per year in “fun” money. That annual or monthly distribution you take would also grow as your original sum and reinvestments. In the fifth year of your investment, it would be producing more than $12,155 in annual income.

“You want to try to leave [the principal] as a cushion that you can use your entire life,” said Adam. “You can hopefully earn dividends and draw income off it indefinitely.”




  1. Kelly says:

    We are debt free except for our home which we are due to close on this month. We have been debt free for 10 years. My hubby & I are both self empoeyld & when our home caught fire & burned 2 years ago, we lost our only way of making a living (we both worked from home). We were homeless & income-less for 5 months. Had we had any payments to make outside of our groceries, etc. we could not have made it. It’s worth it, guys. It’s a pain to cut things back & not get the stuff you want when you want it. I make our laundry detergent from scratch, we use coupons (massive amounts of coupons), we combine trips to town to save gas, we barter services (I am a photographer & often barter for haircuts & even dentist work.) If you focus on away to make it happen, you’ll find a way. If you say Woe is me, I’ll never be able to get out of debt. then you won’t. Whether you think you can or whether you think you can’t, you’re usually right.

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