Smart Ways to Spend an Inheritance

Inheriting money can become tricky quickly. When inheriting money, you may receive 401Ks, IRAs, CDs, brokerage accounts, and more. No matter what you inherit, it can have a meaningful impact on your financial planning. There are some smart ways to spend an inheritance, so in this article, we’ll take you through our top tips when it comes to inheriting wealth.

While receiving an inheritance can be a blessing, it is very important to handle it wisely. When you inherit money, whether it’s just you or your siblings as well, the experience you have will depend on how the family has set up the estate. In some cases, inheritance passes to its recipients very easily. In other cases, those funds can get tied up in probate. You may even be the trustee or executor of the estate, which can be a lot of work. Regardless, it is likely to be a sensitive time, so making smart financial decisions is very important.

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Key Steps to Manage Your Inheritance
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Key Steps to Manage Your Inheritance

1. Assess Your Financial Situation, Including Debt

One of the first things you need to do when inheriting money is to assess your financial situation. Avoid the impulse to make snap decisions or spend emotionally. Sit down and assess your financial situation, including any debts you may have, such as mortgages. Generally, it’s advisable to consider having these debts paid before retirement, so you may want to use any inheritance to pay off some of those large outflows.

Paying off large debts, such as your mortgage, helps lower your monthly expenses and reduce your budget needs. With interest rates high these days, mortgages, credit cards, car payments, and more can significantly drag down your finances. If you choose to pay off debt with your inheritance, prioritize the highest interest debt first.

2. Build Up Your Emergency Savings

You may also consider contributing some inheritance funds to your emergency savings. When you’re in retirement or soon to be in retirement, it’s important to aim for a nice stockpile of money you can access whenever you need it. Building up a nest egg of cash for emergency savings is very important. These days it’s not even idle money; you can put those funds in money markets for a 3% or 4% return, which was rare in the past.

3. Have a Plan for 401K and IRA Inheritance

Another thing to consider is what your retirement portfolio looks like. Take a look at your own 401Ks and IRAs, in the context of what you’re inheriting. If you’re inheriting money through a 401K or IRA, those funds will likely pass to you as a beneficiary IRA. This rule applies to both traditional and Roth IRAs. Under today’s law, you must withdraw all the money from an inherited IRA within ten years of inheriting it. That is one of the reasons why having a strategy on the best way to take that money out is critical. It’s advisable to work with a fiduciary financial adviser who can explore multiple scenarios with you, especially since your strategy may vary depending on the type of account you inherit.

Remember, if you inherit IRA money, it comes out 100% taxable, so if you were to take it all in one year, you may incur a huge amount of taxes. In many cases, it may make sense to stretch out distributions over the 10-year period, taking it in equal portions each year. However, the situation differs for a Roth IRA, since Roth dollars can grow tax-free forever, but still must be distributed. That is why having a plan on how to distribute those dollars can be very important when you receive an inheritance.

4. Invest Your Inheritance

Another good option is to invest your inheritance. Depending on how old you are, you may still have considerable time left in your working career. If this is the case, you may want to consider a longer-term investment approach with assets like stocks, bonds, exchange-traded funds, real estate, multi-year guarantee annuities, CDs, and more. If you choose to invest, diversifying your investments across many asset types may help to spread out the risk associated with it.

Keep in mind that in some cases, unless tied up in a trust or dictated by the trustee, you don’t have to hold the same funds that whoever you are inheriting from held. Instead, you may want to diversify those funds to better fit your goals and situation. While there may be some nostalgia associated with holding the same assets, it’s a good idea to work with a fiduciary adviser to find the best path forward for you and your financial situation.

5. Understand the Tax Implications

Finally, when you inherit money, it’s important to be aware of the potential tax implications. If it’s cash at the bank, chances are you won’t pay much tax. However, if you inherit IRAs or 401Ks, you’ll likely be paying tax when you distribute that money. You can implement some strategies, such as giving charitably, to minimize your tax liability when you’re taking distributions. If you’re over the age of 65, it’s important to recognize that inheritance can cause several stealth taxes. For example, it could push your tax bracket to go up, as well as cause you to pay more tax on your Social Security or even drive your Medicare premiums up.

While inheritance can bring complications, it can also present opportunities. Still, when you’re inheriting money, it can be a windfall that requires lots of decisions. When you inherit money, you don’t want to be blindsided, which is why it’s so important to assess your financial situation and craft your inheritance strategy accordingly. If you want to learn more about ways to reduce your taxes, check out this video from our YouTube channel!

Financial Planning in Austin, Texas

If you’ve recently received an inheritance or are planning for one, thoughtful financial management is essential to ensure long-term success. At REAP Financial, we understand that managing newfound wealth can present both challenges and opportunities. Our team of experienced fiduciary advisers is here to help you make informed decisions, whether you’re focused on debt reduction, investment strategies, or tax planning. We offer personalized, goal-based financial planning services that align with your unique needs.

Located in Austin, Texas, REAP Financial specializes in working with high-net-worth individuals and families, particularly those approaching retirement. Our advisers take a comprehensive approach, looking at every aspect of your financial life, from asset allocation to tax implications. Contact us today to schedule a complimentary consultation and explore how we can help you navigate the complexities of your inheritance and secure your financial future with confidence.