When people inherit large sums of money, their initial reaction is usually excitement and joy for what opportunities it could provide. They rarely consider the possibility they could end up broke and full of regret. But without a plan in place, the latter scenario is more likely than you may think.
Great wealth comes with an even greater responsibility to make that money last and grow it responsibility. Following are a few tips to help you avoid the tendency to squander your windfall and ensure it provides a profitable future.
1. Understand exactly how much you’ve inherited.
Before you jump the gun and start spending, educate yourself. Read the fine print and calculate the taxes for which you’ll be responsible. Ask a financial professional to help identify exactly what your take-home pay will be in relation to your financial responsibilities.
Also, speaking of professionals, be careful of who you trust. Before hiring, do your research and get personal referrals on each individual from whom you will be seeking advice or a service. In addition to a financial planner that has experience with high net worth individuals, you may consider hiring an estate attorney and an accountant to help you preserve your wealth. But be careful to make sure their plans mesh.
You may not realize that with your newfound wealth, you and your heirs may instantly have a tax problem. The federal estate tax exemption—that’s the amount an individual can leave to heirs without having to pay federal estate tax—will be $5.43 million in 2015, up from $5.34 million for 2014. Anything above the exempted amount could be subject to a substantial tax.
An attorney can assist you with structuring various types of wills and trusts so more money goes toward charity and heirs rather than the government.
2. Develop a financial plan that’s in line with your expectations and desires.
Write out a list of things that are important to you—from the type of car you want to drive, home you want to live in, and vacations you want to take, to the amount of money you would like to give away to charitable causes. Now calculate an approximate cost of each of those things and compare it to what you have in the bank. Are your goals realistic?
One rule of thumb is to earmark 10 percent of your cash as “fun” money and at least 10 percent as savings. But, it depends on your situation, the size of your inheritance and the length of time you would like it to last. Obviously, it’s wise to also regularly invest a chunk of your salary in investment accounts that can multiply your wealth for yourself or loved ones down the road. A trusted financial professional can help you decide on what percentage is appropriate for your situation.
3. Be cautious when giving to friends and family.
Some people may view your position as an opportunity for them to get their hands on a piece of your wealth. It can be tempting not to let the generosity flow to friends and family when your sudden wealth is seemingly never-ending. But trust me, it is.
Consider requesting a financial professional to put you on a designated monthly salary and direct requests for money to him or her. This is good way to put some distance between you and your family members and friends.
Speaking of giving to friends and family, remember to update your will or trust soon after receiving your inheritance. Beneficiary designation should be checked and updated on all existing documents, or you could unknowingly bequeath funds to an individual you did you not intend.
Deciding on a power of attorney is also a wise step to take. The person you choose to fulfill this role would make decisions about your affairs if you suffered an incapacitating injury or became too sick to act on your own.
4. Hold off on big ticket purchases at first.
Take some time—maybe as long as a year—before making those big ticket purchases. Pay taxes, get rid of debt, and/or invest in a small vacation or moderate vehicle purchase, but don’t make too many changes at once. After giving your situation some serious thought, consult with a professional about substantial purchases in order to decide whether they're wise investments for this particular time in your life.
Taking a “timeout” before making large purchases allows you to come to grips with your new financial situation, set the stage for better decision-making and get your emotions under control.
The Bottom Line:
Once you begin to become comfortable in your new financial reality, you’ll be better prepared to choose—with the help of a financial professional—whether to buy a vacation home, new car, donate to charities, or set up trust funds for your children.
The ultimate goal from all these steps is to create a sensible plan for handling your new wealth, as well as keep your relationships and emotions in check.