Managing a Sudden Inheritance: How to Build Wealth and Avoid Pitfalls
For those living paycheck to paycheck, receiving an unexpected inheritance can feel like winning the lottery, especially if it’s more than anticipated. In today’s economy, inheritances aren’t guaranteed, and when they do happen, they can significantly impact one’s financial future.
A Washington Post analysis of the Federal Reserve’s 2022 Survey of Consumer Finances reveals that only about one in five U.S. households have received an inheritance. The average amount, around $58,000, isn’t necessarily life-changing. But what if you’re one of the lucky few who receive a substantial windfall?
Consider the example of a single 46-year-old woman, struggling financially, who inherits $650,000 when her mother passes away. How should she invest this inheritance to build long-term wealth and avoid squandering it?
Preparing for Inheritance-Related Expenses
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Before diving into investments, it’s crucial to assess any potential tax obligations. The U.S. doesn’t have a federal inheritance tax, but six states—Kentucky, Iowa, Maryland, Nebraska, New Jersey, and Pennsylvania—do impose one (though Iowa is phasing it out by 2025). Inheritance tax is distinct from estate tax, which is levied on the total value of the deceased’s estate and paid by the estate itself, while inheritance tax is paid by the heir.
If our example woman also inherits a traditional IRA, as a non-spousal beneficiary, she’ll have to start taking required minimum distributions (RMDs), which are taxed as income. The amount depends on whether her mother passed before or after her RMD starting age. If the IRA balance is substantial, she could face a large tax bill.
With brokerage accounts, there will also be tax considerations for capital gains, dividends, and interest payments. Understanding these tax liabilities will help her preserve as much of her inheritance as possible.
Setting Financial Foundations
Before investing, it might be wise for her to tackle any outstanding debts, such as credit card balances or student loans. Paying off high-interest debt can provide more financial flexibility in the long term. Building an emergency fund, ideally covering three to six months of living expenses, is another crucial step. Keeping this money in a high-yield savings account ensures easy access while earning a modest return.
When it comes to her mortgage, she has options. Some might prefer paying off the mortgage entirely to eliminate debt, while others may opt to invest that money, potentially earning higher returns than the mortgage interest rate.
Real Estate Investment: A Profitable Path Without the Hassle
If real estate investment appeals to her, there are ways to gain exposure to income-producing properties without the stress of becoming a landlord. By investing in real estate through funds or platforms, she could become part-owner of a portfolio of rental properties or industrial warehouses, which offer long-term growth potential. The best part? She wouldn’t need to be a millionaire to start, and it can be done with minimal hassle.
Investment Strategies for Long-Term Wealth
Once taxes and debts are addressed, it’s time to consider investing in stocks, bonds, ETFs, and even alternative investments. To minimize risk, she could use dollar-cost averaging—investing a set amount at regular intervals rather than all at once. This approach smooths out the volatility of the market by spreading purchases over time.
Diversification is key to protecting her wealth. A balanced portfolio might include a mix of stocks, bonds, and real estate, each with different risk levels. If she has a higher tolerance for risk, she could explore strategies like short selling, which involves betting against the value of certain stocks. However, high-risk strategies should be approached with caution, especially if she’s looking for stability.
If she plans to retire earlier than anticipated, a more conservative investment strategy may be appropriate. This way, her investments have less exposure to market fluctuations that could wipe out a portion of her portfolio before she has time to recover.
One thing to note: if she inherits retirement accounts, she can’t roll them into her own 401(k) or IRA. However, if her spending is reduced after paying off debts, she could increase her contributions to her existing retirement accounts, growing her future nest egg.
Take Your Time and Seek Professional Guidance
Inheriting money, especially during a time of grief, can be overwhelming. It’s important not to rush into major financial decisions. Parking the money in multiple federally insured banks or credit unions, each insuring deposits up to $250,000, can keep the funds safe while giving her time to evaluate her options.
Working with a financial advisor could be one of the best steps she takes. An advisor can help craft a plan that considers her financial goals, risk tolerance, and the complexities of taxes and investments.
Steps to Secure an Early Retirement
For those interested in early retirement, a personalized financial strategy is essential. Platforms now exist that connect users with vetted fiduciary advisors based on credentials, experience, and pricing—all at no cost to the user. An advisor can guide her through maximizing her inheritance, avoiding tax traps, and ensuring a comfortable retirement.
Conclusion
Receiving an inheritance can transform one’s financial future, but it requires careful planning to ensure it’s not squandered. By paying off debts, understanding tax implications, investing wisely, and seeking professional guidance, this 46-year-old woman can turn her windfall into lasting financial security. It’s not just about having money—it’s about making that money work for her long into the future.
