The “great wealth transfer” is underway, with some $30 trillion being transferred from one generation to the next as baby boomers pass along their life savings to their heirs.
Most heirs are largely unprepared for sudden windfall and the unexpected challenges and risks that can accompany it. Seventy percent of the wealth that gets passed down is lost by the second generation, and 90 percent is lost by the third, according to a survey by The Williams Group.
If you come into a surprise inheritance of your own, follow these six steps to avoid costly mistakes that can deplete your loved ones’ monetary legacy.
1. Take Your Time
The time during which an inheritance is received can be very emotional, and emotional circumstances can lead to hasty and often illogical decision making. “The most important thing about receiving an unexpected inheritance, especially when it’s a large one, is to give yourself a ‘no-decision’ time zone during which you really don’t make any big decisions about the money,” said Colin Drake, a certified financial planner.
One of the most common mistakes Certified Financial Planner Shomari D. Hearn encounters in new heirs is “sudden wealth syndrome.” “The recipient can fall into the trap of believing their newfound wealth will never run out and that they can buy everything and do anything.”
“If necessary, it’s fine to take a small fraction of [the inheritance] to treat yourself,” Drake said. But, he added, “this is not a time to commit to new houses, business or big investment opportunities. Nor is it a time to loan or give money to family or friends.”
2. Assess Your Financial Needs
If you’re not sure what to do with an inheritance, ask yourself these questions about your financial needs:
- Do you have debt to pay off?
- Can you beef up your retirement contributions?
- Do you have a big enough emergency fund?
- Can you contribute to your children’s college fund?
“Let the money work for you,” said tax attorney David M. Hryck. “Instead of rushing out to buy something for yourself, lay out your financial goals and work on accomplishing each one. Be methodical about your decision.”
3. Prioritize Wants and Needs
Between your financial needs, your personal wants and the inevitable flood of requests that follow your inheritance, there might be many sudden demands on your newfound money. If you go after everything all at once, you can find yourself going broke.
“A sudden inflow of money can be great, but often proves devastating in the long run. Just look at all the athletes and lottery winners who suddenly receive millions, and then became bankrupt just as quickly,” said Elle Kaplan, CEO of LexION Capital Management.
According to the National Endowment for Financial Education, 70 percent of people who come into sudden money are broke within a few years. To avoid a similar fate, prioritize all of your wants and needs before making any decisions. Choose two or three top priorities to tackle first and build them into a budget that reflects your new means.
4. Consult a Financial Planner
“Those who don’t know how to handle money urgently need help when in receipt of sudden wealth, and those who manage their finances responsibly should recognize the need for proper counsel in handling levels of wealth beyond that to which they’re unaccustomed,” said Robert C. Drury, executive director of The Association of Christian Financial Advisors.
Stay accountable to yourself and the legacy left by your loved one by working with a financial professional to craft a fiscally responsible plan and stick to it. “A financial advisor can help flush out the long-term goals for your inheritance money and keep you from going off track with short-term wastefulness,” Kaplan said.
Learn more: How Should I Invest My Inheritance Money?
5. Fulfill Your Tax Obligations
Inheritance can be subject to taxes depending on where you live. Tax laws change frequently, so consulting a local tax professional can help you make sure you are properly fulfilling your full tax obligation. As of 2015, six states impose an inheritance tax and fifteen states and the District of Columbia have an estate tax. In those states, many beneficiaries are exempt from paying the inheritance tax depending on their relationship to the deceased.
You can read more on the latest federal guidelines by consulting the IRS website. You’ll also want to set aside the money you’ll need to cover taxes on your inheritance before purchasing or setting aside funds for anything else.
6. Shape Your Legacy
Protect your newfound wealth with proper estate planning. An attorney or estate planning professional can “help you ensure that the wealth you worked hard to preserve and grow will pass to your intended beneficiaries upon your death,” Hearn said. At a minimum, you should update your will or create one if you haven’t done so already.
Depending on your situation, Hearn added, you also might consider more complex planning techniques, such as creating trusts or reconfiguring insurance arrangements.
Your Checklist for How to Handle a Surprise Inheritance
Step 1: Take a Time Out. Take two to three months to think about what you’d like to do with your inheritance before making any major decisions.
Step 2: Pay Your Taxes. If you live in a state with an inheritance tax, be sure to meet your fiscal obligation in a timely manner.
Step 3: Consult a Financial Planner. Work with a financial planner to prepare a full assessment of your financial wants and needs. Craft a specific action plan for fulfilling those of the highest priority within the means of your inheritance funds.
Step 4: Consult an Attorney. Ask a legal professional about the ramifications of any choices you plan to make with your newfound cash. This includes everything from tax implications to setting up a will or trust on behalf of your own beneficiaries.
Step 5: Follow Up. Implement all the professional advice you’ve been given and follow up accordingly. It’s better to make informed choices and stay accountable to your long-term goals than to lose site of the big picture and find your inheritance squandered.