What Should I Spend My Inheritance On?

If you’ve just inherited a significant chunk of money, there’s probably a lot on your mind. Unless it’s from a little-known or long-lost relative, you’re likely dealing with a lot of grief, and maybe many other emotions, that can make healthy decision-making harder. While it’s up to you how you spend, save or invest your inheritance, here are the main things you should consider doing first.

Paying Tax

Whether you have to deal with inheritance tax will depend on where in the world you live. It’s relatively rare in the USA. There’s no federal inheritance tax and only a handful of states impose it. In many other parts of the world, inheritance tax is the norm, but in most countries it’s only charged on quite substantial inheritances.

In practice this means the majority of people will never have to pay inheritance tax. However, it’s important to check and ensure there’s no tax liability in your particular circumstances, before you start spending your inheritance. If there is likely to be a tax to pay, ringfence that money straight away as it will likely fall due with your next tax bill, rather than immediately.

Paying Down Debt

Paying down any expensive consumer debt that you’re currently carrying will invariably be the next thing you’ll want to consider. High interest debt like credit cards should be a priority whenever you come into extra money, no matter where from.

It might be tempting to pay off other debt as well such as a personal loan or mortgage, but consider the interest rate you’re on first, especially if it’s a low fixed rate that isn’t going to suddenly increase. If you’re steadily paying off low interest debt your inheritance might be better invested elsewhere, where it could give you a healthy long-term return. As Bank of America wealth strategies executive Kevin Hindman has put it:

“Does it make sense to pay off a mortgage at a rate below 3%? You might do better than a 3% return elsewhere.”

After paying off high-interest consumer debts, balance any other possible debt repayment plans against the possible returns of investing your newfound wealth.

Topping Up Your Retirement Accounts

According to a poll by Bankrate 56% of Americans say they feel they’re behind where they’d like to be in terms of saving for retirement. Using an inheritance to put that right is possible, although again there are a few issues to think about.

If you have a self-funded retirement account, such as an IRA, perhaps as a freelancer or business owner, you might be able to use some of your inheritance money to increase the amount in there.

Things are slightly different with an employer-sponsored plan, such as a 401(k), as you can’t generally make direct deposits into these. You could however increase your contribution amount through payroll. Perhaps you’ve never maxed out your contributions because you can’t afford to, but you could now pay in more of your salary as you have your inheritance to effectively ‘replace’ it when it comes to every day spending.

Again, you’ll need to look at the big picture and make sure you can meet all your financial obligations, but usually it’s a good idea to pay the maximum amount you can into an employer matched 401(k) in order to make the most of your employer’s contributions and increase your final pension pot.

Creating an Emergency Fund

If you don’t currently have a well-stocked emergency fund, a sudden windfall is a great opportunity to put that right. How much you need in your emergency fund will vary hugely depending on your circumstances. You need to take into account not only your monthly expenses but other factors too. What kind of emergency is likely to befall you, and would things like insurance, worker’s compensation schemes and paid sick leave cover you?

Someone with good health insurance, life insurance, and house insurance along with a job with excellent benefits might not need the same emergency fund as a freelancer with no employee benefits and less extensive insurance policies. Once you’ve worked out what you need in your emergency fund, decide on where best to keep it. You want to be able to easily access it at short notice, but it would also be nice to be earning at least a little interest on it as in an ideal scenario you won’t be digging into it.

Buying a Home

With the cost of housing rising so quickly in many areas (and so completely out-of-step with wage increases) getting an inheritance might be the first chance you get to seriously consider home ownership. In fact, as this Guardian article points out, inheritance has arguably become the main route to middle-class home ownership in the USA.

For many of those in the middle-class and middle-aged category, when parents pass away, they’re often leaving a fully-paid off home that may have increased in value many times over since the purchase date. Even if the proceeds need to be split between two or more offspring, this can result in the beneficiaries having enough for a down payment on a house, often for the first time in their working life.

While this can certainly be a an exciting prospect, it’s important to factor in the ongoing costs of home ownership and be 100% sure that buying a home is the right decision for you, given all your other circumstances.

Investing

Investing the majority of your inheritance may not sound very sexy, which is probably why so many people don’t do it. MarketWatch has reported that one in three Americans who receive an inheritance have spent it, and gone into the red again within two years. Obviously this will include people who use their windfall to pay off debt or buy a house, so it may not indicate that they’re spending it frivolously.

If, however, you’re already ticking along nicely, financially speaking, it makes sense to invest a healthy portion of your inheritance. The type of investment you make will depend on a lot of factors and it’s highly advisable that you talk to a financial advisor, especially if it’s a larger inheritance. As with any ‘found money’ tucking it immediately away into a relatively low-risk and diversified investment portfolio will likely be something your future self will thank you for.

Spending

Having said that, most people, understandably enough, want to do something at least a little fun with their new-found wealth. Many feel that their loved one would even want that for them, in much the same way you’re supposed to spend birthday and holiday cash gifts on something nice for yourself rather than just adding it to the family budget.

If you’re going to spend some – or even all – of your inheritance however, make sure you spend it mindfully. Now is not the time to give in to impulse spending and end up with a load of tat you don’t need. Make sure your spending is aligned with your deepest desires and values, and is something you won’t regret later on. Perhaps having so recently been reminded of how mortality works, you’ll be tempted to spend it on an unfulfilled lifelong desire, or something that includes making lifelong memories with your still-here loved ones.

Helping Others

While it will depend on the details of the deceased person’s Will, it’s often the case that only the spouse or direct offspring of the person who has died are beneficiaries. In that case it’s not unusual to consider passing some of the windfall on to other family members. This might be the perfect time to help your own kids or grandkids buy a car, get on the property ladder, or fund a big life event like a wedding. Just make sure you look into the tax implications of any gifts you give to family.

You may also, of course, want to donate some of the money to charity, especially if your loved one had a favorite cause, or if there’s a charity that supported them during their lifetime. Remember that most charity donations are tax deductible, but again you’ll have to find out what applies to you given where you live and your current circumstances.

An inheritance tends to be a windfall that comes at a sad, and sometimes traumatic, time. Thinking things through and putting a plan in place can mean you give yourself the best chance of making good decisions as to what to do with it.

Karen Banes is a freelance writer specializing in entrepreneurship, parenting and lifestyle. She writes articles, website content, ebooks and the occasional award winning short story. Her work has appeared in a range of publications both online and off, including The Washington Post, Life Info Magazine, Transitions Abroad, Brave New Traveler, Natural Parenting Group, and Copia Magazine. Learn More About Karen