Research shows the average inheritance is spent within five years. As an advisor at Verisail, I have seen both sides of the coin. Some of my clients have done a great job at continuing to live their lives as if the inheritance wasn’t even there. I have witnessed other clients unwisely spend a significant portion of their inheritance, unfortunately. Over the years, I have made some observations about how to appropriately think about an inheritance. Here are a few steps to avoid the most typical inheritance pitfalls.
- Taxes– this should be your first consideration. Federal estate taxes apply for estates that exceed a high threshold—$5.49 million per individual for 2017. A number of states also levy estate taxes; some, like New Jersey, have very low exemption levels, meaning they apply to a lot of estates. An estate is responsible for paying federal and state estate taxes before any assets are distributed to heirs.
- Mental accounting– we tend to treat windfalls different than other money. It’s just one downfall of “mental accounting,” where we don’t think of every dollar as having equal value to another. One study showed that the average heir saved only about 50% of the inheritance money. It is easy to think, “wow I can afford much more with this inheritance now” OR “now that I have this inheritance, I don’t have to save as much.” The best outcome is to use an inheritance to get ahead on your financial goals. Don’t be a victim of mental accounting.
- Inertia– inertia is the enemy when it comes to managing an inheritance. My best advice here is to be proactive about setting goals for putting these assets to work.
- Estate planning– Wealth needs protection. If this is your first time investing or having substantial assets, you’ll want to set up some safeguards to manage and protect your wealth. Double-check your beneficiaries for all of your retirement accounts and life insurance. It’s also a good time to create a will and appoint a power of attorney, if you haven’t already. If you have children, you may also want to set up a trust for dependents. Basic estate planning isn’t always fun, but it’s a crucial step.