What you need to know if you have inheritance money coming your way
Let’s face it, we all secretly fantasize about getting an inheritance from some long lost uncle who we’ve never met. As tempting as it can be to think such a situation would be a long term game changer, however, the statistics suggest that this isn’t always the case. Studies show that one in every three Americans who receive an inheritance somehow manage to completely blow it. Not only do many inheriters end up no better off financially in the long run, some even find themselves in an even worse position than they were pre-inheritance. Don’t let it happen to you. Here you’ll find some helpful hints about what to do with inheritance money, just in case that long lost uncle of yours ever does meet his untimely demise.
Resist your initial temptation to act
While it may be tempting to go all Scrooge McDuck and bathe in a bathtub of bills filled with your new found fortune, this strategy is not the most highly recommended. Likewise, you should more than likely resist the urge to go out and immediately purchase anything with the words like “Gucci” or “Versace” on it. Instead, the best thing to do immediately after inheriting a large sum of money is often nothing.
This is especially true if you actually knew the person who you inherited the money from. In this case, you’ll likely have plenty of emotions to work through about not only the inheritance itself but also the loss of your loved one. In most cases, there’s no need to do anything immediately, so take a few months to grieve before you decide to make any huge decisions.
The other reason it’s wise to hold off on any brilliant ideas you may initially have is that it’s important to understand exactly what you’ve inherited. As you may know, not all inheritances are created equally and yours could come in the form of anything from cash to property to tax-advantaged accounts like an IRA. Things may be a bit trickier on the legal front with some forms of inheritance than others so you may even want to hire a wealth management company, a lawyer who specializes in trust and estate law, or an account who has a lot of experience with this kind of thing.
Inheriting trust or tax-advantaged accounts
What you’re able to do with your inheritance will likely depend a great deal on what exactly it is you’ve just received.
Trusts: In this case, the good news is that the work is pretty much out of your hands. Trusts are generally managed by an investment advisor, banker, lawyer, another family member, or someone who otherwise isn’t you. Just make sure the trustee has your contact information so they can keep you updated on any investments that may be included in the trust.
IRAs or 401(k) plans: If you’ve inherited either of these, then your options are going to depend on whether or not you are the spouse of the person you inherited them from.
If you are the account holder’s spouse, you have one of two options in the case of traditional IRAs or 401(k) plans. You can either transfer an IRA to your own name, transfer a 401(k) to an IRA in your name, or cash the account out. In either instance, your best bet is probably to just transfer the funds to your own name since all the money in them was made with pre-tax dollars. Whenever you do eventually withdraw it, it will be subject to tax. Not to mention that the longer you leave it alone, the more time it’s going to have to grow.
If you inherit your spouse’s Roth IRA, you still have the same two options, potentially minus the need to pay taxes if you chose to cash out. Since Roth IRA contributions are made with after-tax dollars, they won’t be subject to tax when withdrawn as long as the account has been open for at least five years. If it has been less than 5 years, beware that cashing out will subject you to income tax.
If you inherit the 401(k) or IRA of someone who is not your spouse, your options are a bit more limited. If it’s a Roth account, the same rules will generally apply. If, however, it’s a 401(k) or IRA, the IRS will usually force you to withdraw it. While the plan itself may word how you can make the withdraw, if not then you may be able to decide on how long you allow it to remain in the account before withdrawing it.
Inheriting cash or property
In the case of inheriting cold, hard cash or property, the good news is that you aren’t subject to tax. There are occasionally exceptions to this rule, such as inheritance taxes, which are imposed in a handful of states. Otherwise, your options extend to the horizon and beyond. Some of the smarter ones include:
- Paying off high-interest debts.
- Putting aside emergency funds for 6-8 months of living expenses.
- Paying off or paying down your mortgage, but only if you can put aside emergency funding first. It’s no good to be debt free only to have disaster strike and find yourself unemployed or injured with nothing to fall back on.
- Make your money work for you by making a series of diversified investments.
- Save for your kids’ college funds.
- Okay, okay have a bit of fun with some of it. But not too much!