Disclaimer: The information provided is not intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek specific advice from their personal tax or legal counsel.
Losing a loved-one such as a parent can feel impossible. Not only from an emotional standpoint, but also, although less so, from a logistical one when considering the many financial to-dos. We’re here to provide some insight on what you need to tackle first and which items you can leave for after the initial weeks of grieving and coping. This article will help you navigate the impact of an inheritance on your overall financial situation including your net worth snapshot, cash flow, investments, debt, savings, taxes and your own estate plan after assets are distributed.
Over the years, we’ve had clients and the children of clients come to us with recent inheritance. Many have been visibly overwhelmed and deer in the headlights-ish. An inheritance impacts every area of our personal finances and leaves us with a deeply emotional responsibility to “do the right thing, at the right time” with these funds. We’ve found that prioritizing inheritance to-dos into digestible 30-day, 60-day and 90-day items can remove some of the stress and burden.
Assuming the estate has been settled and assets have been distributed, you may be looking at more investments than you’ve ever had, and perhaps more cash than you’re used to. And, you may be wondering: What do I need to do first? Keep these positions? Sell these positions? Buy stocks? Buy mutual funds? Pay off my mortgage? Max out the kids’ college plans? Hire an advisor? Fire the advisor? Decrease my life insurance? Increase my life insurance? And when does this all need to be evaluated (besides right now)?
Well help you understand how an inheritance will impact each of the ten themes of financial planning, what we recommend you do, and when you need to address them:
Phase 1, First 30 Days: Evaluate Everything, Buy & Sell (nearly) Nothing:
The first 30 days after you receive an inheritance should be about evaluating and understanding your full financial picture. During this time, we recommend not rushing into purchasing any big ticket items, or making substantial monetary commitments like paying down a mortgage, buying a house, maxing out kids’ college funds or major investments. If possible, we recommend you leave any inherited investment positions as they are (within reason, and please contact us to discuss these in detail if you have any questions) to allow yourself time to evaluate what you have.
Snapshot: Commit to conduct a deep review of your finances. Pull up to the table with a big cup of coffee and look at what you have. Have each account statement available and assemble a detailed list of every asset you have, including newly inherited items (e.g., cash accounts, investment and retirement accounts, real estate, kids' college plans, bonds) and liabilities (e.g., personal debt, credit debt, student debt, mortgage/real estate, auto debt). We recommend you use a net worth snapshot and ensure you account for everything. Consider putting it all into a financial data aggregating app like Mint or Personal Capital. If you already have online access to your accounts, integrating into these apps usually take 10-15 minutes, and although they aren’t perfect, they're a good first step to get everything in order. For each piece of debt, you should know how much balance is left, what your payment terms are and what the interest rate is.
Budget: Review your cash flow before and after you received inheritance. If you’ve already created a budget, you probably know how much extra or deficit you have each month and where any extra funds should go. If you haven’t created a budget yet, now’s a good time to start so you know where, and how much of the inheritance you can spend in your daily expenses, and how much you should leave for investments, paying off debt, retirement or college savings.
You should consider insurance on any substantial collectibles like art or jewelry if you've inherited any significant pieces.
We typically do not recommend selling any inherited investment positions in the first 30 days of inheritance to allow for time to evaluate and analyze your full investment portfolio. This rule of thumb is more about reminding you to relax, digest what has happened, get things in order, be sure to consider all investments and then evaluate your investments before placing what may end up being excessive or costly trades.
Phase 2, Next 60 Days: Make The Plan
The next 60 days are about making a plan for your investments and overall finances and taking small steps to implement it. At this point, you should know where your assets are, how much they are, and how much (more or less) is in each account. You should understand how accounts are titled (outright in your name, in IRAs, or in trust; these titles are typically listed on each statement and have different tax impacts when withdrawing cash from them) and what is accessible to you for spending or saving.
1. Snapshot and Budget: By now you have a sense of what you have and how much you spend. And, you may be asking the question “where does the next dollar (any excess cash) go?” If you’ve inherited money, do you know into which “pot” it should go (e.g., savings, retirement, college plans, paying down debt, emergency cash reserve)? We recommend tackling things in the following order:
Pay down expensive debt such as high interest credit card or personal debt. And pay off your credit cards each month, no excuses!
Build an emergency cash reserve.
If you have student debt, have a plan on how to pay if off and when.
Save for retirement by maxing out your employer retirement funds to at least get the “free” employer match and if possible, put the maximum amount allowable by the IRS into your account each year. Consider allocating funds to other tax deferred accounts like IRAs if you are eligible.
Plan for college savings. Know how much your kids will need for college and then decide how much you want to contribute to their education. Come up with a plan to allocate funds to college every month.
Evaluate paying down your mortgage. Review your current (and perhaps floating) interest rate, what you pay each month, what the payment terms are and if you have any prepayment penalties. Compare your interest rate to current mortgage rates, and what you could make if you invested excess cash in the market. Typically, this decision ends up being a emotional one, not a financial one. Most people simply want to pay off their mortgage so they can be debt free, even if they think they can make more by leaving that capital in the investment markets. We’re a fan of debt free and the markets. This decision is a personal one.
2. Insurance: Consider changing the amount of life insurance you have. You may be able to decrease or eliminate it by self-insuring. This allows your assets to provide for your loved ones instead of insurance after your passing. We've also seen people increase their life insurance after an inheritance, believing more assets will be required to keep up with a new standard of living.
If you’ve inherited a portfolio of investments like stocks, bonds or mutual funds now is the time to take a deep dive into evaluating what you have. The goal would be to understand what you are invested in (if they are mutual funds, individual stocks or bonds/bond funds), if you're comfortable with the holdings, and if the overall asset allocation mix is appropriate for you. Many times we see inherited portfolios having a more conservative allocation (more weighting to conservative fixed income or bonds, than riskier stock or equity positions) than what would be appropriate for a younger, inheriting heir. However, we strongly caution there is no right answer to what someone’s allocation should be based on their age. This is a decision people must make on their own. There are a lot of free tools out there to determine an appropriate asset allocation mix for you based on your comfort, portfolio size and overall risk tolerance.
If you have inherited an IRA, you must follow the distribution rules to avoid costly distributions. You will have to take a required minimum distribution each year. Your IRA custodian can you assist with this transaction.
4. Income Tax: If you have inherited a substantial amount of inheritance, you may experience a tax impact. The consequence isn't because you automatically have additional taxes due, but rather, an increase in your assets may put you into a higher income tax bracket. Consider a conversation with a CPA at this time.
Phase 3, 90+ Days: Execute The Plan
The last phase of handling your inheritance is finalizing and executing your plan and having a new process to monitor your ongoing financial situation. We recommend:
Budget: You should know where that “next dollar should go” and execute this plan. If you’ve paid down all expensive debt, student debt, are maxing out retirement accounts and want to add funds to your children’s 529s, then set up a plan to do that regularly.
Estate Plan: Revisit your own estate plan. If you've inherited significant assets, it's important that you review your own estate plan to determine what documents you’ll need in place.
Insurance: Consider if an umbrella coverage is appropriate for you. We also recommend that you revisit your home / auto coverage if you’ve inherited significant assets as it may impact the most appropriate deductible and coverage for you.
Investments and Retirement: Come up with a plan to continue to monitor your investments and retirement plan. You’ll need to keep an eye on your overall allocation as the markets move and overtime as you near retirement.
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