Money passed down to the next generation comes with feelings of gratefulness, loss and responsibility. In addition, receiving an inheritance worth hundreds of thousands of dollars can be jarring. It offers an extraordinary opportunity to secure your financial future, but doing so requires knowledge and discipline. From assessing your current financial standing to deploying savvy wealth-building strategies, here are five ways to turn an inheritance into a legacy of financial security and prosperity. You may also want to turn to the help of an experienced financial advisor to help set yourself up for long-term financial success.
Steps to Take When Receiving an Unexpected Windfall
When receiving a large inheritance, it’s crucial to approach it with careful consideration and planning. You can take certain steps in order to help you successfully invest your money or put your money to work for you and to prevent yourself from blowing it all. Here are four common steps you may want to take:
1. Assess Your Financial Situation
You might want to begin by understanding your current financial standing, including your assets, liabilities, income and expenses. Compile a detailed list of your financial holdings. Determine if you have any outstanding debts, such as mortgages, student loans or credit card balances. Understanding your debt obligations is crucial for making informed decisions. Likewise, evaluate your goals so you can orient your spending in a meaningful way. Money has a knack for quietly vanishing when you don’t aim at objectives and milestones.
2. Make a Plan
Define your short-term and long-term financial objectives. For example, you may want to buy a house, save for retirement or start a business. An inheritance can kickstart your efforts and give you a sense of what steps to take. Then, you can create a budget outlining your expected income and expenses. This spending plan will help you manage your newfound wealth and ensure it aligns with your goals.
3. Seek Guidance
Consider hiring financial advisors, estate planners or tax experts. They can provide specialized knowledge and help you navigate complex financial decisions. For example, say you want to put your inheritance towards your retirement savings. Receiving an expert’s advice on account types (such as an IRA or annuity) and asset types (such as stocks, bonds and real estate) can help you see what investments fit your situation, the returns to expect and the taxes you’ll incur.
4. Continue to Assess and Adjust
Just as it’s wise to review your budget at least a couple of times a year, evaluating how your inheritance is affecting your financial circumstances is similarly critical. For example, if the inheritance includes investments, keep a close eye on their performance and diversify your portfolio to manage risk. Financial managers or robo-advisors are excellent resources for rebalancing in response to changing market dynamics.
In addition, if you receive your inheritance in installments, your priorities will likely change over time. For example, you might initially allocate the distributions towards debt payments. However, once you repay the balance, you can set another goal, such as building an emergency fund or saving for a child’s education.
Smart Ways to Build Wealth With Your Inheritance
The following strategies empower you to consistently leverage your inheritance to build and grow your wealth. Remember, everyone’s financial situation is unique, so it’s best to tailor these tips to your specific needs and objectives.
Eliminate High-interest Debt
High-interest debt can throttle your financial potential because of how compounding can work against you. For example, making minimum payments on a $5,000 credit card balance with a 25% interest rate creates a situation where you can’t shrink the balance. As a result, tackling debt that outpaces your asset appreciation rates should be your number one priority. Start by addressing credit card balances, personal loans and student debt. Doing so will save you a significant amount in interest payments and provide you with a clean financial slate.
Build an Emergency Fund
Life rarely goes as planned and an emergency fund is a cushion during times of hardship. So, put away three to six months of life expenses in a separate account to use in case of job loss or high medical expenses. This way, you can fall back on your resources instead of going into debt when you’re in a pinch.
Save for Retirement
Contributing to your retirement account(s) is one of the wisest moves you can make for multiple reasons: first, you set yourself up to enjoy your golden years and second, you’ll receive tax benefits. For example, depositing into a traditional IRA can reduce your taxable income for the current year, while a Roth IRA provides tax-free capital gains.
In addition, saving for retirement provides a concrete goal because these accounts (namely, 401(k)s, 403(b)s and IRAs) have annual contribution limits. Specifically, you can contribute $22,500 to your 401(k)/403(b) in 2023, plus a catch-up amount of $7,500 if you’re 50 or older. You can contribute $6,500 to your IRA in 2023, plus a $1,000 catch-up amount if you’re 50 or older. As a result, these finite amounts are achievable when you have a sizable inheritance to utilize and also allow you to allocate money for other purposes.
Open a Brokerage Account
After maxing out your retirement contributions, you can invest in a brokerage account. This account type has no contribution limits and also provides access to a diverse range of assets such as stocks, bonds, ETFs and mutual funds. The drawback is that your capital gains have more exposure to taxes, whereas retirement investment vehicles generally provide some sort of tax benefit. That being said, a brokerage account allows you to transform a windfall into a self-perpetuating investment fund you can tap at any time without penalty.
Diversify Your Investments
Spread your investments across different asset classes (e.g., stocks, bonds, real estate) and industries. Diversification can reduce risk and potentially increase your overall returns. If one investment performs poorly, the gains from others can offset those losses, preserving more of your initial investment.
For instance, bonds may offer stability during economic downturns while stocks may decline. Having a mix of assets allows you to adapt to changing circumstances. In addition, holding on to specific stocks despite falling prices allows you to profit when the market rebounds. Therefore, a diversified portfolio tends to be more stable over the long term. It’s less likely to experience extreme fluctuations, which can help you stay on track towards your financial goals.
Bottom Line
Managing a significant inheritance requires a thoughtful and strategic approach. By following the steps above, you can navigate the complexities of newfound wealth and set a solid foundation for financial success. Remember, each individual’s financial situation is unique, so it’s important to tailor these strategies to fit your needs and goals. With careful planning and informed decision-making, your inheritance can be a powerful tool to create lasting financial security and prosperity for yourself and future generations.
Tips for Building Wealth With an Inheritance
- Passing money down in an intentional way usually requires a detailed plan and a vehicle such as a trust. In addition, both the older generation fostering the wealth and the younger generation that will put it to use can optimize their financial approach to minimize taxes and maximize gains. A financial advisor can help you fine-tune this kind of plan. Finding a financial advisor doesn’t need to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re planning on leaving money for your beneficiaries, you can start now to reduce the total gift amount and avoid taxes. The gift limit for 2023 is $17,000 per gift per person, providing an excellent opportunity to be generous and mitigate estate transfer taxes.
Photo credit: ©iStock.com/Edwin Tan, ©iStock.com/davidf, ©iStock.com/PixelCatchers