I write this blog having recently spoken with a number of prospects and clients about their thoughts related to inherited wealth. Or similarly, acquiring a whole bunch of money through a sale, equity compensation, investment, or a gambling windfall. For perspective, I’m focusing on something in the realm of $200,000 – $2,000,000. Although this can certainly apply to larger amounts.
How does inherited wealth or windfall impact your financial outlook?
I generally see new wealth of this amount and nature addressed two entirely different ways.
One – The inflow is almost ignored. It will likely be that much more inheritance for the recipient’s heirs or go toward potential elder care preferences. It’s not changing the recipient’s day-to-day lifestyle. It’s not changing their attitude. They likely had little or no stress about money to begin with, so while this inherited wealth is a welcome boost and added peace of mind, it doesn’t change anything. And for those people, this money is simply folded into their current savings or investment strategy. Where they benefit is leveraging a financial planner for consideration as to which type of account to add it to for maximum tax, risk tolerance, and diversification efficiency. They may also be advised on now-possible gifting strategies and relevant estate planning techniques.
Two – The wealth is a new experience, and can be overly relied on. And this inherited wealth may have already been counted on to stabilize their financial situation. And the word that comes up a lot in these situations is the recipient, for once, doesn’t feel “behind.”
- Behind for retirement savings.
- Behind on saving for their children’s education.
- Behind on where they envisioned their general lifestyle to be. Maybe to the point that they’re experts in juggling debt to make it all work.
And this new money solves this feeling of being “behind.”
And as wonderful as the feeling of being “caught up” is, that’s where we need to proceed with caution! That’s when the money can be over-relied on.
These are the top ways I see inheritance being spent:
- Ongoing spending: the ability to not feel so frugal and enhance your lifestyle. This may be committing to new or upgraded expenses (new car loan, private school tuition, being generous with family, book the expensive vacation, financing a new or secondary home, taking a nicer apartment).
- Lump spending: the ability to finally do that home improvement project, get solar, pay cash for a new car, invest in a business venture, paying off past debts.
- Funding future goals: this is your chance to make up for lost time as maybe you haven’t been able to contribute much (or anything) to retirement, down payment, or college goals. By setting the money aside, you’ll finally be on track.
What I find all too often, is even if receiving upwards of $1,000,000 or more, it simply doesn’t go as far as one thinks.
A million dollar windfall can likely do one thing really well. Or a couple things well. But three or more things? You’re probably going to end up feeling behind again because the money is now serving too many masters.
Having a financial planner run the numbers can illustrate your parameters if the money must accomplish a bit of each. Setting expectations correctly, and early, is critical when every dollar counts. And if there is an option to fund multiple priorities, a planner can help identify where you’ll receive the most value among your varied aspirations.
For example, those who haven’t saved anything for retirement thus far, probably won’t be in a position to save much going forward. Nothing has changed about their income or cash flow. So earmarking the money for retirement can be a great strategy. And it could very well mean that not only have they made up for lost time but are now in a position to no longer worry about saving at all. What they make, they spend. How freeing! A financial planner can recommend assumptions to forecast how the inheritance will meet your eventual retirement or earmarked goal. And to the extent it’s overfunded, figuring out how much surplus could be allocated elsewhere is the fun part (like distributing an extra $500/mo for spending, or getting squared away with a new car, furnace, or education goal)!
Accounting for Taxes
And it’s also worth mentioning that it’s wise to keep taxes top of mind when receiving wealth. A $1,000,000 inflow could materially shrink in a blink for that reason alone. Potentially nothing is owed, which is great. But if you’re receiving gambling winnings, a retirement account or something with low/no cost basis, there is plenty to keep in mind for tax time. And the timing of making tax payments to avoid interest and penalties, or taking IRS required minimum distributions from retirement accounts are important to understand.
Managing inherited wealth or windfall responsibly requires careful planning, thoughtful decision-making, and a healthy dose of self-awareness. Working with a financial planner can help you navigate all there is to know about making high-value choices and avoiding trouble at tax time.
