Money Smart: Have You Received an Inheritance?

The Do’s and Don’ts of a sudden financial windfall.

Grace S. YungSeptember 1, 2022

174 4 minutes read

An inheritance can come in many different forms, including investments, real estate, cash, and life insurance proceeds. While most people relish the idea of receiving a nice windfall, the passing of assets and property doesn’t always go as planned or expected.

Statistics show that the average inheritance is spent within 18 months. This can be due to several factors, but more commonly it is because people just don’t know how to manage money.

Because of this, it is recommended that you get advice as soon as possible from financial, legal, and accounting professionals. Otherwise, you may find yourself with far less money than you had hoped for.

Devising a Good Strategy

Whether or not you anticipated your windfall, it may be tempting to go out and spend it all right away. But that might not be the best idea, especially if you don’t already have enough money set aside for the future.

Here are a few strategies that can help you manage inherited funds:

• Work with a professional financial planner to build a financial road map. This is critical in keeping you on track with preserving, growing, and protecting your newfound wealth. Also, your planner can act as the “quarterback” of a planning team that includes a CPA and an attorney to help you with tax and legal matters.

There may be tax liability on what you inherit, and the CPA can help you from that standpoint. (For instance, some inherited funds such as life insurance proceeds are not taxable as income to the beneficiary upon receipt. But if you generate inter- est or other earnings on the inherited cash, investments, or property, these earnings could be taxable.) And an attorney can help you establish or revise a will or trust as a way to help you protect your assets from liability and to transfer them in the future.

• Carve out some fun money. While you shouldn’t spend all of the funds that you receive from an inheritance, individuals who leave inheritances often want their loved ones to have some enjoyment with the money.

• Lay out a plan to generate current and future income to make your inheritance work for you. Your planner can help you design an income plan that coordinates with your other income sources like Social Security, a pension, and/or government retirement-plan benefits.

Other Inheritance Options

There are other options for your inherited funds, depending on your goals. These may include:

Donating to a charity or other similar organization.
If there is an organization that is close to your heart, you could consider donating some of the inheritance. Doing so may produce tax advantages for you, as well.

Paying off or reducing debt.

If you have any outstanding loan balances— including a home mortgage—you may want to pay down some of the balance with the funds you’ve inherited. Each situation is different, so it may or may not make sense to keep a mortgage. Your advisor can evaluate your particular situation.

Building an emergency fund.

An emergency fund can provide you with a financial cushion if you need to make unexpected home or auto repairs, pay for medical expenses, or if you lose your job or other sources of income.

Establishing a college fund for children or grandchildren.
Higher education costs continue to rise, so if any loved ones plan to attend college in the future, some of your inheritance could go to pay these costs. Discussion with your advisor here is also important, as you want to be aware of the pitfalls of gift taxes.

Leave a legacy to honor your loved one.

You could honor the individual you received the inheritance from by creating a legacy in their name. This could take on many forms, such as establishing a school scholarship fund or providing the needed cash to build an animal shelter.

Other Things to Consider

Any time large sums of money are involved, there are important issues to be aware of before moving forward, such as:

Risk.

If you want to grow the money you have inherited, it is critical to avoid risky investments where you could lose some—or possibly even all—of your inheritance.

Taxes.

You could owe taxes on interest, dividends, and/or gains that you generate from the money you have inherited. Also, if you inherited an IRA account or other retirement funds, there will be ordinary income taxes due on withdrawals—or hefty penalties on any account funds that are not withdrawn in accordance with IRS timelines.

Asset transfers.

While most people don’t like to think about it, you should put a plan in place specifying what will happen to any unspent funds remaining at your death. If you have a domestic partner or a marriage that isn’t legally recognized, it is important to take precautions to ensure that the money goes to the person you intend it for.

This can be particularly important for those in the LGBTQ community facing uncertainty over same-sex marriage laws.

Getting Additional Guidance

While receiving a large sum of money can be exhilarating, it can also cause some challenges with regard to how you should protect, spend, save, invest, or donate it. With that in mind, working with a qualified planning professional is recommended.

Grace S. Yung, CFP ®, is a Certified Financial Planner practitioner with experience in helping LGBTQ individuals, domestic partners, and families plan and manage their finances since 1994. She is the managing director at Midtown Financial Group, LLC, in Houston. Yung can be reached at [email protected]. Visit letsmake aplan.org or midtownfg.com/lgbtqplus.10.htm.