The First 5 Things You Should Do When You Inherit A Large Amount Of Money
According to SmartAsset, a financial technology company, 70% to 80% of American households aren't likely to see an inheritance, and of those that do, only one-third will receive money. Of those households that do inherit money, the average is $46,200, per data from the Federal Reserve, yet the top 1% of households is largely responsible for the average being as high as it is, with this group inheriting $719,000. The lower of 50% households inherit $9,700, or 1.34% of the top amount.
With this said, a recent national survey of 6,000 households conducted by Hearts & Wallets found that 49 million U.S. households expected inheritance in 2022 versus 34 million in 2015, with 54% of this group having investable assets under $100,000 — which points to a rise in inheritances among middle-class that have minimal experience managing inheritances.
A 2023 New York Life survey, meanwhile, found that less than half — 42% of Americans — who anticipate inheriting money or property feel confident in their ability to handle it, with six out of 10 adults believing mounting credit card debt, inflationary pricing, and interest rates will take a major bite out of their inheritance. If you believe an inheritance is in your future, here are the first five things you should do when you inherit money.
1. Don't spend the money for at least six months
As explained by the Corporate Finance Institute, a behavioral condition called mental accounting is common among people who suddenly come into large sums of money. Research has found that the value individuals place on money has a direct impact on their ability to make rational decisions about it. Most people come from a budgeting mentality informed by lack rather than extra funds, so when someone suddenly inherits money, they may spend the windfall more recklessly than usual as there's a perception the new money is a gift, and, therefore, meant to be spent differently than their usual money. It's one of the main reasons people who win the lottery still end up dead broke.
So one of the first things you should do after inheriting a large sum of money is to do absolutely nothing. Seriously. Leaving your inheritance in the bank for at least six months, preferably in a low- risk higher-return investment vehicle — a high-yield savings account, for instance — allows you the space to build incrementally on your inheritance, while also taking time to solicit knowledgeable financial advice from an accredited professional.
Depending on your inheritance, you can reach out to an accountant, insurance agent, investment broker, estate lawyer, tax attorney, or real estate professional if a property is part of the inheritance or you're thinking about purchasing a property. One important tip for choosing a financial adviser is to approach someone with significant experience and a track record of good advice backed up by reviews.
2. Take care of your debts
Getting past mental accounting means thinking about what you owe now and what you'll need later. The financial experts at Debt.org note that debt for households in America reached a whopping $16.9 trillion by the end of the fourth quarter of 2022, an increase of $2.75 trillion from 2019. Of that, $986 billion was due to credit card debt, while $11.92 trillion of that was incurred by mortgages. Student debt and car loans made up $1.6 trillion and $1.55 trillion, respectively. And, with the median income in 2022 totaling $56,368 and the average American household debt approaching $101,915, the odds that an inheritance will find you owing money to some entity is pretty decent.
According to the Credit Counselling Society, paying off and closing out lines of credit will prevent you from incurring more debt. The goal should be to pay off as much debt as possible, and if you can get away with paying off your mortgage without facing steep penalties, do that as well. If you have a maxed-out credit card or two, take the opportunity to improve your credit score by paying off your credit card debt or loans. Give yourself the gift of a one-time debt consolidation loan free of interest rates, pay schedules, or origination fees. This isn't just a financial gift for yourself but can prove to be a psychological one, too. As explained in a story by NerdWallet's Sarah Rathner, via The Associated Press, debt-related stress can cause elevated blood pressure, heart rates, sleeplessness, and stomach issues. Eliminate your debts and improve your financial, mental, and physical health.
3. Establish an emergency fund
According to Lending Tree, 58% of Americans don't have money put aside for emergencies, with 27% ending up in debt due to unexpected expenses beyond their ability to cover. In cases where Americans find themselves in debt, the debt has usually accrued to a sum over $5,000. Even worse, many Americans in this situation will reach for a credit card to help cover their emergency needs, which places them in an ongoing cycle of debt, with an average interest rate of 24% added on for good measure.
To build your emergency fund, start by setting achievable goals for yourself, as suggested by the Consumer Financial Protection Bureau. A swift lump-sum inheritance makes that a little easier to manage since you know exactly how much money you have on hand after paying off debts. Working from past experience, put aside enough money to cover the unexpected, while building on that emergency fund with consistent contributions your salary allows.
Your bank or credit union is the safest place to keep/build your emergency fund, while a prepaid debit card is also a great second option. While it's our least-favorite due to the potential for loss, theft, or damage, storing cash in a fireproof safe is another viable option. If your money is sitting in a bank, however, let it do some work for you at the same time via an interest-bearing account that won't be hit with banking fees, will actually grow in value, and is easy to access when needed.
4. Invest for the future
If you've done the responsible work of paying off your debts and building up a rainy day fund for emergencies, you should be thinking about the future. Hopefully, you took our first piece of advice and reached out to a team of smart financial experts. Somewhere in that team, you should have an incredible investment professional who can offer you tips for investing as a beginner. Considering your appetite for risk and avoidance of unnecessary taxes will help your planner figure out the best plan for you, through low-risk investment opportunities like corporate bonds and treasury notes, or high-risk vehicles like stocks or cryptocurrency (note, where the latter is concerned, crypto scams are on the rise and should always be considered high risk).
If you inherit a home and it's not a mansion, you're likely safe from any additional tax burden, per SmartAsset. However, if you choose to sell the home, capital gains taxes could enter the picture to the tune of 10% to 37% of the sales price. Renting the home out provides more passive income you can use to help save for retirement while paying off the mortgage on the property. which is also an appreciative asset. Understand that any mortgage left on the home is now your responsibility, along with property taxes, utilities, insurance, and maintenance fees. With that in mind, make decisions about renting, selling, or moving into the home based on what's financially sensible for you. An adviser can help with that.
5. Have some fun
What's the point of being responsible and practicing restraint with your windfall if you don't get to enjoy any of it? Once you've done all your due diligence in terms of financial planning, paying off debts, and building savings and investments, you've earned the right to enjoy the remainder. This is obviously based on the size of your inheritance and what's left over from it, but even 10% of a lower average of $9,700 will leave you a couple of hundred dollars for a few dinners at some restaurants you've been dying to experience.
Buying experiences will add more happiness to your life than things. Trips, classes, and adventures tend to create joyful memories you'll carry with you for life, making an experience the gift that keeps on giving. According to a study published in the British Journal of Social Psychology in November 2022, spending money on things that get you closer to attaining intrinsic goals — i.e., goals related to relationship building, personal/professional betterment, and assisting others — led to greater feelings of happiness. If you're receiving an inheritance, someone close to you has likely died. What better way to celebrate their life and generosity toward you, than by doing all the responsible things they would have hoped you would do while also focusing on your happiness?