Receiving an inheritance is one of those times in life where it can truly be bitter-sweet. If you are so fortunate to get an inheritance, that means that the person who gave it to you loved you enough to think of you in their passing. That means that you should honor the person who gave it to you. Let me show you how I have advised former clients and friends on how to spend an inheritance.
Consult an Accountant
Most inherited money is not going to be taxed. However, there are situations where the money that you get from the passing of someone else will, in fact, be taxed. It’s not extremely common, but it does happen. The last thing you want to do is get behind on your taxes because you didn’t withhold enough money to pay Uncle Sam. So just to make sure, talk to a CPA. And make sure it is a CPA, not someone who knows about taxes or your friend who is an “accountant”.
A CPA will be able to walk you through the intricacies of inherited money should there be any. They have licenses and have to take a rigorous set of exams to claim the title of Certified Public Accountant. It won’t cost you very much money (and it might even be free) and could very well save you a LOT of headache.
Honor the Person Who Gave You the Money
This is the main point of this article.
If someone loves you enough to give you a piece of their wealth upon their passing, make sure that you make them proud with what you do with the money.
Ask yourself, what would make the person who gave me this money smile if they were still here?
Likely, blowing the money on stupid or frivolous items would not make them happy. Spending it wisely would.
Also think about the personality of the person who gave it to you. Did they HATE having debt? If so, it would likely make them happy to know that you paid off debt with their money.
Was saving for retirement an important part of their life? If so, strongly consider putting the money into retirement accounts.
Did they like to travel? If so, maybe a vacation in their honor would be appropriate.
Every situation is different. Just make sure that you don’t blow the money that someone gives to you upon their death.
If, after all that, you are not completely sure what to do with an inheritance, here are my general guidelines on what to do with inherited money. Step by step.
First: Save the Money
I know this is the most boring answer that you could think of, but this might be the most important.
If you don’t currently have a 3-6 month emergency fund, you need one. It’s not a matter of if, but a matter of when an emergency happens to you and you need to be prepared.
An inheritance is a great way to get ready for an emergency.
If you are not sure if you need a 3 or 6 month emergency fund, here is an article where I explain how to choose the size emergency fund you need.
If you have an adequate emergency fund, then you can skip this step. Or if you use part of your inheritance to finish off your emergency fund, then move to the next step!
Second: Repay Family Debt
This is a little bit of a hot take, I know. Paying off family members is not something that most people put at the top of the list. After all, most family members (and close friends) who have loaned you money usually don’t charge interest.
So why should you pay off 0% interest debt first? Because you don’t want your relationship to change or be altered because of money.
When people who are close owe each other money it can get weird and awkward in the event that you are not able to pay on time.
I have seen it happen dozens of times in my career. And I’ve even been in that boat myself.
If you have debt to family members or close friends, just pay it off. It will take a lot of stress off of your plate and make you sleep better at night.
Third: Pay High Interest Debt
If you owe money on high interest debt it is a real killer to your financial life. If you owe money on credit cards, it doesn’t matter how much money you are investing and what interest those investments are earning, you will still fall behind.
What should I do with an inheritance?
If you have high interest debt, pay them off with your inheritance.
And to be clear, “high interest” is not always the same for everyone. But for nearly all people, any loan (other than a mortgage) that is >7% should be considered “high interest”.
Fourth: Put it into Retirement Accounts
After you have saved an emergency fund, paid off family and close friends, and paid off high interest debt you should move into putting that money into your retirement accounts.
This is really important if you feel like you are behind on saving for retirement.
This can come in a number of ways.
If you have a 401k, 403b, Simple IRA, etc. through your job you can bump up your withholding from your paycheck for a pay cycle or two to equal the amount from your inheritance that you want to go into your retirement account.
But an easier way to do it is to simply open up a Roth IRA or a traditional IRA and put the money in there.
Either way (or a combination) works. But if you feel like you are behind on retirement savings, an inheritanceis a really good way to start getting caught up.
Fifth: Pay Off Low Interest Debt
After you have done all of the items before, now you can start paying off low interest debt. This would generally be debt of <7%.
The reason that you save low interest debt to the end is because low interest debt hurts your financial life the least.
High interest debt really stings. Not having an emergency fund can be really dangerous. And not paying family members money that they lent you can make Thanksgiving dinner a little weird.
But once you have all of those items done, then feel free to move on to low interest debt.
Final Thoughts
As I said before, inheritances can be tricky. There is often a LOT of emotion and pain wrapped around them. I have had it happen to me personally. And I have seen it happen to several clients over the years as well.
Just make sure that you make the person who thought well enough of you and loved you enough to give you part of their estate proud.
Make them proud.
You can do this!
I am here for you!
Until next time!
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