Over the next 10 years, there is anticipated to be the largest wealth transfer in the history of the United States. This is due to the fact that younger generations are expected to inherit around $16 trillion over the next decade. Consequently, this will leave many heirs feeling both lucky and lost. For many individuals, this will be the first time managing such a large sum of money and many of them won’t know how to invest or spend it. Here are a few vital tips that may help you make better choices during a time that can be very emotionally-charged, leading to impulsive decision making.
Resist the Urge to Spend Immediately
Inheritances tend to arrive during challenging times, and your initial reaction may be to spend money impulsively. Make sure that you give yourself time to grieve properly before making any big financial decisions. The first few weeks and months are going to be about dealing with the paperwork and legalities associated with wealth transfer. Your main focus during this period should be on securing assets, collecting statements, death certificates, wills, and so on. When you suddenly have access to more money than you are accustomed to, it is easy to develop a case of ‘Lamborghini fever.” However, this is one of the quickest ways to lose money that could have potentially set you up for many years to come. It may be a good idea to assemble a small team that can help you, such as an attorney, a tax consultant, and a fee-only financial planner.
Park Your Money Smartly While You Decide
You don’t necessarily need to invest or put your money to work from the very first day of inheriting money. Many advisers suggest that you wait around a year before making any big decisions regarding your inheritance. Meanwhile, there are ways to smartly park your money somewhere where it still earns interest until you are ready to make a decision. Many savings and money-market accounts pay around the mid-4% range at competitive banks. This way, you can buy yourself time and keep your options open without leaving cash at near-zero. Use this time to take care of any high-interest debts and start mapping out your goals for the short and long term. Think about how you wish to address important areas in your life, such as housing, business ideas, and even retirement.
Gain a Better Understanding of How Taxes Apply Depending on Type of Asset
Taxes on an inheritance depend on what you received. Taxable accounts include individual stock or funds, real estate, and brokerage accounts. When a person dies, these assets typically get a “step-up in basis”. This essentially resets their cost to the market value on the person’s date of death. If you decide to sell soon afterwards, there is very little or no capital gains tax. If you choose to keep the asset and it grows from the reset value, only the later growth will be taxed when you eventually sell.
The rules are different for retirement accounts, where most non-spouse heirs are required to empty the account within 10 years. However, there are exceptions when it comes to spouses, minors, and a few other cases. When it comes to estate and inheritance taxes, only very large estates owe estate tax on a federal level. Certain states also charge inheritance or estate taxes with lower limits. If the assets of your family include a farm, business, or several properties, it may be a good idea to talk with a tax consultant and estate attorney.
Think Long-Term
After the shock fades and you have taken time to grieve, start working on a long-term plan so that the money supports your life. Put the cash away and create an emergency fund that will cover around three to six months of expenses. If you are thinking about buying a home, first price the full costs involved before you shop, including maintenance costs, taxes, and insurance costs. You should also consider setting up automatic transfers to savings and retirement accounts. Also, be aware of the concentration risk. Say, for example, you inherited a house or a stock, don’t let it dominate your finances. In this case, you should think about selling or diversifying, especially when step-up in basis limits taxes.
As tempting as it may be to go out and spend money all at once, especially when you are young, it is better to be smart. Wealth transfer can either set you up for life or it can provide a few short years of a lavish lifestyle, buying expensive objects that quickly lose value. In many cases, people spend money to help them grieve. However, it is far better to put the money away for a while until you have figured out a long-term plan that can benefit you for decades to come.
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