Receiving an inheritance can be an emotionally and financially impactful event. It often occurs at a time when emotions are already running high due to the loss of a loved one. This mix of grief and a sudden financial windfall can lead to confusion and even mishandling of the inherited wealth. Astonishingly, a significant number of individuals who receive inheritances find themselves facing more financial challenges than they had before.

The Inheritance Statistics Don’t Lie

A 2012 research study conducted by Jay Zagorsky at Ohio State University, revealed that approximately 33% of individuals who inherit money find themselves with less savings than before within just two years of receiving their inheritance. Astonishingly, among those who inherit $100,000 or more, nearly 20% spend, donate, or completely deplete their windfall.

The statistics on this are telling. A sizable portion of heirs who come into substantial sums of money – whether from an inheritance, insurance payout, or other sources – discover that these funds can quickly slip through their fingers. For some, the money they intended to provide financial security becomes a source of stress and worry. It’s not the inheritance itself, but how it’s managed, that makes all the difference.

How to Manage Inheritance Wisely

So, if you’re one of those who’ve recently received an inheritance, whether you’re in California or elsewhere, here’s how you can ensure it’s a blessing and not a burden:

1. Take It Slow

Inheritances often come at an emotionally turbulent time. It’s okay to take a step back. Don’t rush into major financial decisions while emotions are still raw. Keep the money safe in a bank account for now, and give yourself the time and space to grieve and come to terms with your new financial reality.

You could also use this time to think about what you would like to do with these newfound assets. However, don’t get stuck in this limbo for too long. About six months should be enough time. Also, it would be wise not to go telling people about your inheritance, as this can attract unwanted attention and advice. Limit the number of people who know about it, preferably your trusted family members and friends.

2. Work with Professionals

Seeking professional guidance is one of the wisest steps you can take. Estate planning attorneys, financial advisors, and accountants can help you navigate the complexities of your inheritance, from understanding tax implications to making investment choices that align with your financial goals.

3. Create a Financial Plan

Develop a clear financial plan that outlines your short-term and long-term financial goals. This plan should take into account your current financial situation, your inheritance, and your aspirations. Regularly review and adjust your plan as needed.

4. Pay Off Debts

If you have debts, consider using part of your inheritance to pay them down. Start with high-interest debts, like credit card balances or student loans, as these can erode your wealth quickly. Low-interest debts, such as a home mortgage if applicable, require a more subjective evaluation. If having a mortgage-free home would provide you with greater financial security, it’s entirely reasonable to consider using your inheritance to pay it off. Reducing your debt burden can provide financial freedom and peace of mind.

5. Invest Your Money

Putting your inheritance to work through smart investments can provide long-term financial security. Diversify your investments and consider long-term financial goals, such as retirement savings or funding your children’s education. 

Here are some options you could consider:

• Direct your inheritance towards your retirement plans: If feasible, explore the option of fully funding your tax-advantaged retirement account, like a 401(k) or traditional IRA, up to the maximum contribution limit. This includes taking advantage of catch-up contributions if you’re over 50.
• Establish an Emergency Fund: Accumulating savings equal to 3-6 months’ worth of expenses in a money market account can transform significant emergencies into minor inconveniences, providing you with financial security during unexpected situations.
• Invest in Your Children’s Education: While there are numerous strategies to cover college costs without dipping into your inheritance, if you’ve lagged in saving for your kids’ education, consider allocating a portion of your inheritance into an Education Savings Account (ESA) or a 529 plan. This way, you can catch up on building a fund for your child’s college education.
• Mutual Funds: Mutual funds offer a means to diversify your investments across various securities, including both bonds and stocks. Expert fund managers handle the investments for you, distributing them across different companies and industries to help minimize risks.
• Exchange-Traded Funds (ETFs): ETFs share numerous characteristics with mutual funds. With ETFs, you invest in a pool of stocks to achieve diversification. They are generally more liquid, and it’s common to experience better returns when holding them for the long term.
• Index Funds: Index funds, whether in the form of mutual funds or ETFs, are designed to track specific sectors of the economy, aiming to provide broad returns. Widely recognized index fund choices include the S&P 500 Index and the Nasdaq 100.
• Individual Stocks: Stocks are known for their volatility, offering both substantial growth potential and a significant risk of loss. If you opt for investing in individual companies, consider allocating a predetermined portion of your portfolio, perhaps around 5%, to these high-risk investments, while the other 95% can consist of assets like your 401(k), IRA, mutual funds, and bonds.
• Bonds: Bonds provide a secure means to invest your money and typically yield a relatively modest but predictable return. They can be employed to safeguard funds needed in the near future or to balance the more volatile components of your investment portfolio.
• Real Estate Investment Trusts (REITs): REITs enable you to invest in commercial real estate companies and partake in the profits without the hands-on management responsibilities typically associated with real estate investment.

6. Resist Lifestyle Inflation

It’s natural to want to enjoy the fruits of your newfound wealth, but be cautious about dramatically increasing your spending. Avoid extravagant lifestyle changes that can quickly deplete your inheritance. For instance, while purchasing property may seem like a good investment, you’ll have to pay for the upkeep of that property plus property taxes.

Your inheritance can be a gift of lasting financial security when managed wisely. Seek professional guidance, create a thoughtful financial plan, and make deliberate choices to secure your financial future. If you’re uncertain about the best way to manage your inheritance, don’t hesitate to reach out to us at Hermance Law. We specialize in estate and crisis planning, including the smart management of inheritances. Your financial well-being is our priority.