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.
An inheritance can be a wonderful way to increase your financial stability – if handled correctly. It can be the foundation for your retirement, a charitable giving strategy, or a support resource for your family’s livelihood. Unfortunately, this is not the way it happens many times if not gone about strategically. 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 following a realistic plan
It is a wise choice to consult a professional and develop a realistic financial plan when receiving an inheritance. While this is good advice for any situation involving 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!
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 receiving 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 when receiving an inheritance
If the amount of money you get when receiving an inheritanceis 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 on charitable donation strategies.
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.” Not only can you make a legacy donation, but you can maximize your tax savings, allowing you to give a larger gift or preserve the money for other goals. 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 after receiving an inheritance. As a financial advisor in David County, 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.
Takeaways on Receiving an inheritance
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.
We are a wealth management firm located in Davis County, Utah and serving clients across the country. We place an emphasis on helping our clients use their financial resources to achieve their purpose and contribute great things to society. We focus on individuals, families, or business owners. We provide financial planning and investment management.
There are several reasons why an advisor may be wrong for you, ranging from the inappropriate to the criminal. Finding a great financial advisor is important because of the critical role they play in your ability to reach your goals, whether they be retiring with dignity, making a larger charitable contribution to the world around you, buying a house, putting your kids through college, and beyond.
As a financial planner in Utah serving clients across the country, this is a decision we encourage any prospective client who contacts us to take seriously, with a high degree of objectivity, awareness, and logic.
Here are the common traps we see individuals falling into when they choose a financial advisor. We hope our guidance may help you make the right decision.
Types of financial advisors to avoid
Generally, advisors you’d like to avoid fall into one (or more) of the following categories:
- Advisors who, despite a well-meaning attitude, don’t seem to get things right. Some may not have the right experience or education, while others may have a philosophy that doesn’t match up with yours. These advisors may give you the time and attention you deserve, but their results are lackluster or worse.
- Advisors who work on commissions. These advisors may constantly press you to move from one investment to another (known as churning) and/or to contribute every spare dime you have to your investments. Churning can be lucrative for advisors because they charge for each transaction.
- Advisors who are simply criminals who direct clients’ money into shady companies they controlled or outright steal money from their clients
Naturally, you want to avoid all these advisors. But, because there is no requirement for someone to use the title “financial advisor,” how can you tell a good financial advisor from a bad one?
Below are 7 signs that should make you wary that a prospective advisor is bad news.
1. “Hurry! Act Fast”
A big red flag is advice to act quickly before the opportunity disappears. High pressure or using fear to get you to make a quick decision is a sales tactic. If they are using high pressure sales, they may not have your best interest at heart. And they might just be a good salesperson, not a quality financial planner. If an advisor encourages you to make an immediate, emotional decision, walk away!
2. “Guaranteed” High Returns
This type of advisor is all too willing to boast about returns that you are guaranteed to enjoy. These advisors may try to impress you with a wall-full of diplomas and certificates. They then let you in on “a secret” or two that they reserve for their “best clients.” (Who exactly are their other clients?) They may even have fancy presentation materials that supposedly prove their assertions. If it seems too good to be true, it probably is. In order to get returns, you must be willing to take on some risk or pay some sort of cost. If they aren’t properly educating you on the risks and costs associated with the returns, there is something missing from their fancy presentation.
3. More Concierge Than Advisor
Beware of advisors who tout all the wonderful services and personal attention they give you. It might be a cover-up for poor returns. Naturally, you want an advisor to be courteous and attentive, but you should expect no less, given you are paying for the service. What you deserve is an advisor who has a professional work ethic and can show you how they will add value to your financial plan.
4. How Do They Get Paid?
When advisors push only mutual funds or annuities that pay them compensation or the same investments for every client, this could be a red flag. The advisor may have a quota to sell a certain product or get paid more on one type of investment than another, even if it is not in the best interest of the client. Insist on understanding how your financial advisor gets paid, including all the costs and fees of your investments – and get it in writing. Ask about commission costs and 12b-1 fees or other sales-based fees in investments like mutual funds. And ask about custodial and trading fees.
5. Split Personalities
The advisor you choose to work with should be a full-time fiduciary, meaning they put your interests first and act exclusively in your best interests. This is the highest standard of care. A fiduciary will sacrifice fees in order to put clients in the most appropriate investments. Advisors not held to a fiduciary standard may be more interested in finding you “suitable” investments that are more expensive. It’s not always a problem, but you will want to at least evaluate it carefully.
6. One-Size-Fits-All Solutions
Advisors who offer only cookie-cutter or one-size-fits-all plans aren’t really doing much for you. This can arise when an advisor is compensated by selling a plan, meaning putting you in preselected investments that pay the advisor high commissions. You don’t need an advisor to be a stock-picker, but you should demand attention to your specific circumstances and needs. Part of your interaction with an advisor should be agreement on your goals and how success will be measured.
7. No Credentials
A good financial advisor should have credentials besides just the title of financial advisor. As stated earlier, there is no requirement to use the term “financial advisor.” Look for an advisor with the CFP® or the CERTIFIED FINANCIAL PLANNER™ designation. This designation means they have experience and education in financial planning. And they are held to a high standard of ethics. Many designations require advisor to get continuing education and stay up to date on new research and changing tax laws. Without some evidence of training and education, you may just be meeting with a smooth-talking salesperson.
Finding a Good Financial Advisor
There are many ways a good financial advisor can set up their firm to provide quality service. The advisors practice under these standards:
What does this mean?
A financial advisor who can offer independent financial advice is not directed by shareholders or a far-removed corporate office. They are not tied to proprietary production or minimum production requirements and can offer a broad range of investment options.
Fee-only financial advisors are paid only by their clients, removing even the perception of a conflict of interest. They are not paid by commission or outside outfits, meaning their compensation depends on the job provided to their clients.
A fiduciary financial advisor follows the highest standard in the financial services industry, with a legal obligation to put clients’ best interest first. Other advisors are only held to a suitable standard, meaning they can recommend a product that may have a cheaper, better alternative, as long as it’s suitable for a client’s situation.
For more on what this type of service looks like, click here.
There are a thousand ways to find a financial advisor who is wrong for you. You’ve worked hard to accumulate your money, so make sure you work just as hard to find the right financial advisor for you. Don’t just type in “financial advisor near me” into a search bar and go with the first name that pops up. Try “fiduciary retirement planner near me” or “Certified Financial Planner Utah,” and then follow up. Ask questions. Get the answers in writing.
At Rock House Financial, a fee-only financial advisor in Farmington, Utah, we are charitable giving tax mitigation specialists. We work with families, business owners, and individuals who wants to make an impact through giving.
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If you’d like to explore if we could be of help to you regarding how financial affairs (including the implications of your inheritance on your finances), please schedule a time to speak.
Rock House Financial (RH Advisors) throughout this website has provided links to various other websites. While the firm believes this information to be reasonably reliable, current and valuable to its clients, The firm provides these links on a strictly informational basis only and cannot be held liable for the accuracy, time sensitive nature, or viability of any information shown on these sites.
The opinions expressed herein are those of the firm and are subject to change without notice. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Any opinions, projections, or forward-looking statements expressed herein are solely those of author, may differ from the views or opinions expressed by other areas of the firm, and are only for general informational purposes as of the date indicated.