When a loved one dies and leaves you an inheritance, it often comes with a cache of guilt.
“Most people are not prepared for the emotions that come with an inheritance,” said Stephen Wright, a financial planner with The Enrichment Group in Miami. “It’s different than winning the lottery. When you win the lottery, you’re excited. With an inheritance, it’s bittersweet. You feel guilty for benefiting from the death of a loved one.”
The biggest mistake people make when they inherit a chunk of money is not thinking it through, said Meg Green, a certified financial planner and CEO of Meg Green and Associates in Miami. “People who don’t have means often squander the money on things they have been dying to have all these years, and then it’s gone.”
That kind of thinking wastes an opportunity. “Sometimes an inheritance is the IRA that never got funded; it’s the retirement fund that never got saved,” said Green, who writes the Miami Herald’s Money Dilemmas column.
An inheritance can move a struggling worker from just-getting-by to financial security, Green said. Instead of funding a splurge like a Porsche, that money can better be used to pay down the mortgage or kids’ college, creating long-term security.
One challenge: Recipients may feel the need to do things in a way that their benefactor would have approved, especially in the case of a parent, Wright said.
“You may feel like you have to continue investing the way they did, even if that may not be the best thing for you,” Wright said. “There’s a reason your loved one wanted you to have the money. They gave it to you because they loved you, and because they wanted you to make your life better. Give yourself permission to do that.”
When an inheritance comes your way, financial experts offer this advice:
• Avoid hasty decisions: Slow down and don’t invest in anything immediately. “When people go through traumatic financial situations, they feel like they need to make decisions right away,” Wright said. “People make rash decisions like paying off the house, or feeling guilty and giving the money to charity or other people.”
• Take a cooling off period: Put aside the money until you can think about your long-term goals. Leave it in cash or park it in CDs until you can process the traumatic emotions that go along with an inheritance, Wright said. Consult a financial planner to see what next step is best for you, “depending how much money you get, and how much you have,” Wright said.
• Stop and look at your financial picture: Review your current retirement savings, debt and emergency savings. “Figure out what the inheritance will do to you and how to incorporate it into your world,” Green said. Do a financial plan; see what’s going on in your life; talk openly with your family, and see how it can enhance you, your children, and your spouse, she said. Taxes, long-term health costs and likely social security cuts should all be factored in. “Make the plan before your eyes get as big as saucers with dollar signs on them,” Green said.
• Get professional advice: If it’s a small inheritance, $20,000 or $30,000, that’s not going to change your world, Green said. But it’s still smart to consult a financial planner, if you don’t already have one.
“It’s not as simple as opening up a Schwab account and starting to buy stocks,” she said. “Look for an advisor, but not an advisor who is licking their chops.” Sometimes those who receive an inheritance get rushed into listening to family members or well-meaning friends.
“Three to five years later they say ‘Why did I do that?’” Green said. “For some people, it’s the first time they’ve had money, and they’re vulnerable to the wolves in sheep’s clothing.”
If it’s a substantial inheritance, assemble a team: an attorney, a certified public accountant and financial advisor, to minimize your tax burden and plan for the long term, she said.
• Secure your retirement: “Don’t be the kid in the candy store…let it feather your nest a little,” Green said. The retirement plans that most people put away are not going to retire them, she said. “They’re not going to be able to live on an IRA or social security for the rest of their lives, if they haven’t saved more. This becomes their extra savings, and they get a cushion.”
• Don’t pay off debt without changing habits: If you are deeply in debt, an inheritance can get you back to ground zero, but you have to change the behavior that got you into debt in the first place, Green said. “Paying off the debt and charging it all up again means you have just blown the one chunk of money you were getting in your lifetime,” she said.
• Keep the money in your name: Inheritances are not part of your marriage. If you take an inheritance and put it into a joint account, you have just given your spouse 50 percent of the money, Green said. Because of the high rate of divorce, Wright said they advise clients to keep inheritance money in their name, rather than putting it into a joint account with a spouse.
• Build a legacy: Receiving an inheritance is a great time to do some planning and build a legacy that can be passed on to future generations, Wright said. “Someone of means who has enough money and feels that they are set can pop it to the next generation in a trust and create a legacy for the family,” Green said.
• Handle IRAs carefully: If you inherit a traditional IRA from a spouse, you can roll it over into your own IRA and the rules for required minimum distributions will not change. If you inherit a traditional IRA from someone else, you have two options, said Kenneth Strauss, a certified public accountant and certified financial planner with Berkowitz Pollack Brant Advisors and Accountants in Fort Lauderdale. One is to take minimum distributions based on your life expectancy. The other is to withdraw all funds within five years, beginning Dec. 31 of the year after the IRA owner dies. If you don’t follow the rules, there is a 50 percent penalty, Strauss said. Consult a tax advisor to see what best fits your situation.
• Increase your liability insurance, if needed: Depending upon the assets you inherit, you could be a more attractive target for lawsuits. If you inherit a homesteaded house or an IRA, those are protected from creditors. But money in individual accounts in your name is unprotected. Consider increasing liability coverage on your home and car. “Umbrella policies are so cheap that we usually recommend them, especially in South Florida, where there are so many uninsured motorists,” Wright said.
• Up your standard of living gradually: To protect your principal for your lifetime, the rule of thumb is to spend no more than 3.5 percent of the total money annually, so you don’t deplete the portfolio, Wright said. “You don’t know what investment returns you’re going to get in the future, so the goal is to make sure you can sustain your lifestyle, regardless of what the investment markets do,” he said.
• Don’t quit your job right away: “Not having to work deprives you of the meaning and fulfillment that you can get from your career,” Wright said. Green said people have to think about benefits such as health care before leaving a job.
“An inheritance may make you feel wealthy for a short period of time, but wealthy people don’t want to sit around and do nothing….How many rounds of golf can you play?” she said. “Think first. Don’t focus so much on the money. Don’t make it your whole life.”
• Don’t count your chickens: Don’t go on a spending spree now in anticipation of a big windfall. Health care and nursing home costs are up. People are living longer. “You might not get the inheritance you expect,” Wright said.