Receiving an inheritance can feel like a financial windfall, helping with debts, student loans, or living expenses. However, it can also bring challenges for those unsure of how to handle it. This article outlines common missteps that people make when managing their inheritance and how to avoid them.
Disregarding Professional Advice
Financial, legal, and tax advisors should be consulted when inheriting money. They will advise inheritors on their state’s laws and help avoid potentially costly DIY financial planning mistakes and unpaid taxes.
Succumbing to Family Pressure
When a person inherits money, it is theirs alone. They shouldn’t succumb to family expectations and pressures to spend or invest the money; they should seek expert, impartial financial advice to ensure they are making a plan that is best for them.
Skipping Emergency Fund Establishment
Bankrate defines an emergency fund as “money in a bank account that’s set aside for unplanned expenses, such as medical bills, car repairs or home repairs.” Inheritors should establish emergency funds with inheritance money if they don’t already have one. Bankrate recommends having at least 3–6 months’ living expenses in an emergency fund.
Overlooking Tax Implications
After inheriting money, it is important to understand the difference between inheritance tax and estate tax. Investopedia notes that “both levies are based on the fair market value of a deceased person’s property, usually as of the date of death,” but that the estate pays estate tax, and the beneficiary who inherits the inheritance pays it—consulting a tax professional for advice when inheriting money is essential to avoid mistakes.
Neglecting to Update Estate Plans
When inheriting money, wills and trusts may need to be updated, and a comprehensive state review may be necessary. Merrill stresses the importance of updating estate plans upon inheriting money, noting that “you may need to consider how to protect certain newly acquired assets.”
Ignoring Investment Diversification
Investing money from an inheritance can be a good idea, but it should be an appropriate portion. Consulting a financial advisor for a custom investment strategy is a good idea, especially if the inheritor has never invested.
Overlooking Inflation
Inflation should be factored in when inheriting. While it can increase the value of assets, it can also cause unwanted outcomes for estate plans. As the rate of inflation rises and falls, an estate plan should be annually assessed, with the value of assets and tax thresholds to avoid financial mistakes.
Misjudging Liquidity Needs
When inheriting money, it is important to understand the liquidity of the assets received. Cash and money in bank accounts are liquid assets that can be used to pay off debts and meet financial obligations, while real estate and closet-held businesses are illiquid assets. Assessing liquidity needs is vital when inheriting short-term and long-term cash needs.
Rushing Financial Decisions
Spending large sums of money on a new car, timeshare, or hobby may be tempting when inheriting money. But as Ramsey Solutions advises, it’s better to go slow. They advise inheritors to “take some time to mourn” and “focus and make a plan for your inheritance.”
Falling for Scams and Schemes
Consulting financial advisors before investing money is essential to avoid falling for common financial scams that target inheritors. Expert advice protects inheritors and their inherited assets and can verify legitimate inheritance investments.
Failing to Pay Off Debt
Inheritance money can be a massive relief for those struggling to pay off high-interest debts on top of other expenses. Investopedia notes that “paying off high-interest debts such as credit card debt is one good use for an inheritance.” Getting rid of this debt can massively improve credit scores and overall financial health.
Assuming the Money Will Last for Life
Receiving a large inheritance can lead to a false sense of financial comfort. An initially large amount can vanish relatively quickly on everyday spending, living expenses, and holidays. To avoid this, inheritors should create a financial plan that realistically lays out how the money will be spent.
Avoiding Financial Literacy Improvement
Understanding financial basics is especially important for those inheriting money and other assets. Inheritors should seek to improve their financial literacy to avoid making costly mistakes. There are endless resources for education on investing, taxes, and estate planning that offer inheritors long-term benefits.
Underestimating Emotional Spending
Rock House Financial warns of the pitfalls of underestimating the influence of grief when spending inheritance money. “Your mindset could be clouded, and making any kind of rash financial decision—or any decision for that matter—in this state of mind can lead to expensive mistakes and wasteful spending.” Creating strategies will help to avoid emotional financial decisions.
Mismanaging Real Estate Assets
Inheriting property can be challenging, with upkeep and taxes to keep an eye on. Like inheriting cash, inheriting property comes with a wide range of options, with important decisions about whether to sell, rent, or keep it as a second home.
Forgoing Charity and Philanthropy
Giving to a charity that an inheritor is interested in or has an emotional connection to can be a rewarding way to spend inherited money. Rock House Financial notes that giving to charity in a relative’s name can help to “maximize your tax savings, allowing you to give a larger gift or preserve the money for other goals.”
Lacking a Long-Term Perspective
Inheriting money is a blessing and should be viewed in the long term. Financial goals that align with inheritors’ life objectives should be set up, for example, paying off student loans, buying a home, or paying tuition fees for children.
