Inheritances: 7 Real-Life Scenarios and 7 Rookie Mistakes

Receiving an inheritance is a blessing and an honor, but it can also be a confusing process, fraught with tough decisions, temptation and of course, grief.

It can be hard to fight the desire to spend extravagantly – after all, you may have just received a sizable windfall you didn’t have to work for. But letting your newfound wealth burn a hole in your pocket, and other common mistakes people make after receiving an inheritance, can chip away at that windfall in a hurry.

At Rock House Financial, we want to help you identify 7 real-life scenarios where you could run into trouble. Unfortunately, beneficiaries often make major financial mistakes that could have been avoided when they inherited money.

Mistake #1: Not Talking with a Financial Advisor to Create a Plan

If you take anything at all from this article, please consult a professional and develop a realistic financial plan for the money. While this is good advice for any money, it’s more important than ever in the case of inheriting a large payment or property. Not having a financial advisor or a plan is probably the single biggest mistake people make. The waste, risk and costs can be catastrophic. We’ve seen real-life scenarios where this has happened.

A financial advisor can help you:

  • Create a comprehensive plan
  • Lay the groundwork for investing some or all of the inheritance
  • Prepare cashflow projections
  • Set and keep track of goals
  • Prioritize savings and spending
  • Understand and comply with tax laws
  • Minimize tax liability
  • Maximize retirement savings
  • Make decisions on unfamiliar or confusing issues

Think about going to the grocery store without a list. Do you often add items to your cart that you weren’t planning to buy? This can be especially tempting when you come into a sudden windfall of money. And while the amount may sound like a lot at first, money can be spent fast when you don’t have a plan, sometimes even without knowing it!

 

Let’s talk! Rock House Financial offers several ways to meet with us. Schedule a meeting that works for you!

 

Mistake #2: Spending Money Too Quickly

Spending money too quickly is a huge potential pitfall for heirs. It may be hard to resist the temptation to treat yourself, but an inheritance can help you reach your long-time financial goals if you let it!

Using the money for short-term goals, like a boat, a timeshare or new cars for the family, can be fun, but these purchases can quickly depreciate in value. Instead, if you used the money to fund your retirement, pay off your mortgage early or send your kids to college, you can not only benefit from tax breaks, but you can create an income stream that helps you over time, allowing you to still reach your short-term goals but on a schedule. And using that money for your long-term goals can help your loved one’s legacy last. I had a friend who received an inheritance from her father’s early death. A few years later, she expressed regret that all the money was gone and she was not sure where it all went. She regretted that she had nothing to show from the legacy her father left her.

It’s wise to avoid making any large or significant purchase of any kind right away, especially since you may still be navigating the grief and stress of losing a loved one. Be cautious even making smaller purchases, because they can add up quickly. Case in point: A $5 latte five times a week will ultimately cost you $100 a month.

Mistake #3: Making Emotional Decisions Based on the Financial Windfall

If the amount of money you inherit is substantial, you may think retirement is no longer a concern and stop your retirement contributions or decide to quit your job. But that can be dangerous. The money can be life changing, but so can the loss. Don’t lose sight of that.

Losing a loved one is difficult, and probably not the best time to make big lifestyle changes. Your mindset could be clouded, and making any kind of rash financial decision – or any decision for that matter – in this state of mind can lead to expensive mistakes and wasteful spending.

Here again is another very good reason to talk to a financial advisor and map out a plan. Deal with your grief, ask for help and avoid making any major life decisions until you’re better prepared.

Mistake #4: Assuming a Large Amount of Money Will Cover You for Life

Receiving a large windfall of money can also create a false sense of financial comfort. What seems like a large amount of money can be eaten up very quickly by living expenses and everyday spending, like housing payments, groceries, utilities and so on.

If you have a plan, one that realistically explores what you’ll use the money for and how long it can be reasonably expected to last, there won’t be surprises like a prematurely tapped-out bank account.

Mistake #5: Giving Money to Charity Without Doing Your Research

You might be surprised that we’re discouraging charitable giving. But we’re not! We’re simply discouraging you from giving too suddenly or too generously, when there are ways to do it that can benefit a charity of choice and you as well. Read our recent blog post: Donating to Charity? Rock House Financial Shares 6 Ways to Do So.

Making a contribution to a charity in your relative’s name, one that he or she held near and dear, can be a wonderful thing, but it can be even better when done “right.” Talk to your financial advisor to determine a strategy that works best for you.

Be cautious about giving money away to friends and family too quickly as well. As a financial advisor in Utah, I have seen the potential issues and complications that can arise from dealing handouts, from jealousy and entitlement to an open-ended drain on your inheritance. I have seen many widows make immediate gifts of money to children, to help them handle the loss of a parent, to then later discover they needed those funds for living and have put themselves in a precarious predicament. Creating a plan can still allow you to make gifts while making sure you are taken care of as well.

 Mistake #6: Investing Everything

If you’ve never invested before, the financial world can be a daunting and overwhelming process to navigate. Don’t let that discourage you from investing an appropriate portion of your inheritance, and don’t let it encourage you to invest it all just to be done with it.

There may be smarter ways to put your inheritance to use based on your current and future financial needs. Maybe you have high-interest credit card debt or student loans you can erase. Maybe you don’t have a comfortable Rainy Day Fund. Maybe you own a business and have loans with hefty monthly payments. Whatever your situation is, it’s important to address your needs and plan for how to use the money before you tie all of your inheritance into an investment account you can’t easily access. Or tie it all into debt payoff that you cannot take back.

 Mistake #7: Not Considering Taxes

Taxes can be substantial and therefore, should be considered in your financial plan. There are many variables here, from the different types of assets you might inherit to the types of tax you might be responsible for.

It might be tempting to pull out an inherited retirement account and pay off your house for example. However, the tax consequences will be felt later after you cannot undo it. A large taxable withdrawal could push you into a higher tax bracket, causing more taxes that you think. Beyond that, your taxable income is used to determine a lot of other limits too, such as if you can make a Roth IRA contribution, ability to qualify for certain credits, how much of Social Security is taxed, your Medicare premiums, etc. The interest saved on paying off the house may be a drop in the bucket compared to the tax impact.

New changes in required distributions from an inherited retirement account due to the SECURE Act of 2019 are important to consider when claiming the account and deciding how to invest and take the money out over time.

Talk to your financial advisor, tax professional or accountant to make sure you understand your options and how your decisions can affect your tax liability.

Takeaway

If there is only one thing you take away from this article, let it be to consult a financial professional to help you create a financial plan. This simple step can help prevent you from making a host of mistakes that can cause your inheritance to disappear in less time than it takes to endorse a check.

If you’re currently looking for a financial advisor in Utah or feel it’s time to make a change, contact the team at Rock House Financial. Locally owned and independent, Rock House Financial is passionate about helping you create a more confident financial future. Our team of advisors works on a fiduciary level and offers fee-only financial planning, investment management and tax strategies to help you minimize financial stress and achieve your goals. Contact us, and get the conversation started.

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