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How to Be a Good Steward of Your Inheritance

retirement charitable estate planning taxes investments debt

When you receive an inheritance, you may experience a gamut of emotions. You’re saddened at the personal loss that has led to pecuniary gain. You’re happy to receive whatever you have, and awed at the life’s work than has yielded you a bounty. Your first instinct may be to rush out and buy that nice car you’ve had your eye on for years; however before you make any large purchases, you might want to slow down and think about what good you can do with the money or assets you’ve received.

Understand Your Situation

Before you make any major moves, you review your situation and do an assessment of where you stand financially in an attempt to determine the best moves with your inheritance. What does your debt look like?  Where do you stand with your emergency fund?  Are you on track for retirement?  What other major purchases might be necessary?  By understanding your situation, you can begin to prioritize and take appropriate steps.  You should consider seeking the help of someone that can help put the pieces together and provide you with a financial roadmap. 

Clear Yourself of Debt . . . or Someone Else

Depending on the size of your inheritance, there may be no excuse for continuing to carry large amounts of bad debt. If you have such debt, you may want to start by looking at how best to approach paying it down. You can pay off credit card balances, car notes, and other debt  with your newfound wealth.  We consider bad debt to generally be high interest rate debt that is not deductible and not used to improve your financial situation.  With good debt, more analysis should be done regarding whether to pay down the debt. A good idea regardless is to go through your options with an advisor that is well versed in a variety of financial issues and that is not solely focused on the debt issue in isolation.

Invest and Plan for Retirement

While it is tempting to spend for short-term needs or pay down all debt, one of the best things to do with an inheritance is to allow you to get caught up or ahead of the game for your own retirement.  You are likely (hopefully!) already thinking of savings, Roth IRAs and other investment strategies upon receiving an inheritance.  Assess where you are in terms of meeting your retirement goals with detailed analysis and then determine how this impacts your retirement plan. Will this put you on track?  Or, can you now perhaps retire earlier than planned. 

It is likely that the inherited assets will need to be sold and reallocated to help meet your goals. Consider the impact of income taxes and your overall asset allocation. Take an aggregate view of your inherited assets with your company's retirement plans, your IRAs, and other investments.  

 Of course, you'll want to balance planning for retirement with debt reduction as well. 

Take Care of Family and Consider Your Own Estate Plan

Your immediate family may not have needs right away. However, you should start to think about the future, especially if you have children or grandchildren. Factor an inheritance for your loved ones into your estate plan.  Estate plans should be regularly updated with a change in tax laws and a change in your personal situation.  Receiving a sizable inheritance is certainly one of those changes that may necessitate you revisiting your estate plan.  You may need to change the age at which your heirs receive assets or consider some form of a testamentary trust to more fully protect the assets.  Reviewing beneficiary designations of any inherited IRAs is critical to minimize the family's long-term income tax liabilities associated with IRAs.

Boost a Worthy Charity 

If you are knowledgeable about finances, you know of the tax benefits of charitable donations. Giving to a charity may help reduce some taxes owed thanks to your new capital gains. You will also be contributing to your community or an organization in ways you could not before. You may establish a trust that will help fund a charitable organization for years to come. As a nice touch, you could establish the trust in the name of the family member that passed on. In light of recent changes to income tax laws, however, the rules have changed slightly.  Some strategies to potentially maximize the tax effectiveness of charitable donations include bunching itemized deductions and the use of Donor Advised Funds.

You don’t have to limit the gift-giving to a charity. You can spread the wealth among family and friends. Gifts have tax implications like charitable donations, so it’s something you will want to talk about with a financial planner.

Take Great Care

Many people joke about spending their paychecks before they receive them. That may be the case for you and your inheritance, especially if it is something you have been anticipating. You may want to resist the urge to splurge. You may also have previously unknown to you relatives approaching you with “fantastic” notions of business opportunities that can’t miss, or those who are in dire need. Think hard and do your homework before rushing into anything.

Talk Things Over and Seek Assistance

You shouldn’t make these big decisions alone if you hope to pay forward the legacy you received. Of course, you can talk things over with family members, though finances can be a difficult topic. You can address these issues with an multi-disciplined wealth advisor who is well versed in finances, taxes and investments, but be weary of an advisor that wants to quickly put you in high commissioned products.  The advisor should be quick to listen and slow to make recommendations.  There are a handful of fee-only advisors in most cities. You can look at organizations such as Alliance of Comprehensive Planners or National Association of Personal Financial Advisors  for a list of advisors in your area.

This content is developed from sources believed to be providing accurate information. The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.