You Received an Inheritance, Now What?

Receiving an inheritance can trigger mixed emotions. On one hand, you’ve experienced a tangible personal loss, while on the other you’ve received a monetary gain.

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Receiving an inheritance can trigger mixed emotions. On one hand, you’ve experienced a tangible personal loss, while on the other you’ve received a monetary gain.

The difficulty in inheritances lies in deciding what to do with this sudden financial windfall. While inaction is the biggest pitfall facing heirs, a Lund university study suggests that an average inheritance is gone within five years as a result of financial mismanagement.1 Instead, heirs should consider investing these assets in taxable accounts, or in property assets.

To help prepare, here are six practical steps for what to do when you’ve received an inheritance.

1. Resolve Taxes

Your first consideration should be taxes. There’s a difference between estate taxes and inheritance taxes. Federal estate taxes apply for estates that exceed a high threshold—$5.45 million per individual for 2016. A number of states also levy estate taxes; some, like New Jersey, have very low exemption levels, meaning they apply to a lot of estates. An estate is responsible for paying federal and state estate taxes before any assets are distributed to heirs.

But some states also apply inheritance taxes, which must be paid by the beneficiary—you. At present, only eight states have inheritance tax, and many beneficiaries are exempt, like children of the deceased. The best thing to do is consult a CPA or tax advisor to determine if you must pay inheritance tax.

2. Know the Pitfalls

We tend to treat windfalls differently than we treat other money, according to behavioral economist Richard Thaler. It’s just one downfall of “mental accounting,” where we don’t think of every dollar as having equal value to another.

A few pitfalls come with this line of thinking:

Failure to save. Because we think of windfalls as “found money” and tend to put it in a different mental category than regular income, we don’t always spend or save it in the same way we do with earnings.

Lottery winners are an obvious victim of this logic; one study found that winners only saved about 16% of their winnings.2

For heirs, the numbers are better, but not by much—one investigation found the average heir saved about 50% of an inheritance. Another study out of Denmark finds that the average inheritance is gone within five years, unless invested in financial assets or housing equity. An inheritance left in cash is particularly vulnerable to being spent, rather than saved.

Bad spending behaviors. What’s alarming is that an inheritance is likely to crowd out good savings behaviors, the Danish study found.

Here’s how it happens: An inheritance makes your cash balance spike. You spend a little on early splurges, and start to slack on long-term saving habits. This behavior snowballs, and a few months or years later, you face two consequences: the inheritance has been spent completely, and you’ve lost the good fiscal habits you had before.

Buying without thinking long-term. Some people fall into the trap of using an inheritance for a big purchase, but then consequently over-extend themselves. For example, let’s say you use the inheritance for a down payment on a bigger house.

Along with a bigger house comes new furniture, but also higher property taxes, home maintenance costs, homeowner’s insurance, and monthly utilities. Your monthly expenses can expand quickly while your income stays the same.

3. Consider Your Financial Goals and Invest Accordingly

Knowing that these tendencies put both your inheritance and your hard-earned savings habits at risk, the best thing to do is set goals for putting the assets to work.

Take time to look seriously at your short- and long-term goals, like paying down debts, and saving for a home or retirement.

Inertia is your enemy when it comes to managing an inheritance, and the best way around that inertia is to outline a goal-based investing strategy.

In goal-based investing, each goal will have different market risk exposures depending on the time you have set for reaching that goal.

Goal-based investing matches your time horizon to your portfolio’s asset allocation, which means you take on the appropriate amount of risk. Short-term goals are better suited to less volatile assets such as bonds, while long-term goals are better suited to riskier allocations, with  potentially greater returns.

One goal may be to shore up your emergency fund, if needed. An adequate safety net is a must-have at any stage of life.

Your windfall may also provide an opportunity to pay down debts, typically starting with any uncollateralized loans (for instance, credit cards or student loans), or loans on depreciating assets (like car loans).

You may also consider paying off a mortgage, or refinancing to a better rate that can be achieved with more equity and a lower principal loan amount. A primary mortgage is typically a last priority, since you may receive tax benefits from mortgage interest, and have a better opportunity to put that money to work harder for you in a diversified portfolio with a higher expected rate of return.

4. Assess Your Retirement Contributions

Make sure to contribute the maximum allowable amount to retirement accounts for the year. The amounts may be small compared to your overall inheritance, but retirement plans come with tax benefits that you’ll want to capture.

With an employee-sponsored plan like a 401(k), you are limited to contributing from your salary, so increase your contributions to the limit, or even up to the amount where your employer will provide a matching contribution.

You can also contribute up to $5,500 for yourself and another $5,500 for your spouse, if married, into a tax-deferred IRA account. If you’re a Betterment customer, its retirement investment strategy can help you figure out the right mix.

5. Invest for the Long Term

Knowing that an inheritance left in cash tends to disappear, make sure to follow through with the long-term portion of your plan. If your emergency fund, debts and retirement plans are on track, the rest of your savings is probably best invested in a taxable brokerage account, according to Betterment’s goal-based investment method mentioned above.

If you have a more specific goal in mind, like a home purchase in the near future, consider an investment strategy for a major purchase goal.

And if you do decide to use the inheritance for a major purchase—like a house—give careful consideration to what your normal income allows, as far as ongoing monthly expenses. The goal is to nurture your good savings habits over the long term.

6. Establish Estate Planning

Wealth needs protection. If this is your first time investing or having substantial assets, you’ll want to set up some safeguards to manage and protect your wealth.

Take time to double-check that you’ve set beneficiaries for all of your investment accounts. It’s also a good time to create a will and appoint a power of attorney, if you haven’t already. If you have children, you may also want to set up a trust for dependents. Basic estate planning isn’t always fun, but it’s a crucial step.

Putting your inheritance to work on your short- and long-term financial goals is a great way to avoid spending down an inheritance left in cash. But to truly avoid the pitfalls of inheriting, be mindful of maintaining your long-term savings habits. The best outcome is to use an inheritance to get ahead on your financial goals, while still nurturing good day-to-day spending and savings behaviors. In this case, knowing is certainly half the battle.

1  The Effect of Unexpected Inheritances on Wealth Accumulation: Precautionary Savings or Liquidity Constraints?, pg. 13. 2  Estimating the Effect of Unearned Income on Labor Earnings, Savings and Consumption: Evidence from a survey of Lottery Players, Pg. 16.

Research shows the average inheritance is spent within five years. Here are six steps to invest smartly and avoid the most typical inheritance pitfalls.

27194 2016-05-23 10:22:04 2016-05-23 14:22:04 2019-10-05 16:41:22 2019-10-05 20:41:22 received-an-inheritance betterment_editors Display top featured image inheritance Research shows the average inheritance is spent within five years. Here are six steps to invest smartly and avoid the most typical inheritance pitfalls. Should You Invest, Or Pay Off Debt? https://www.betterment.com/resources/invest-or-pay-off-debt/ Thu, 14 Jul 2016 16:05:17 +0000 nholeman https://www.betterment.com/?p=27727 Should you invest your money or use it to pay off existing debt? It’s a tough question, and one we receive often at Betterment.

As a fiduciary, it’s our responsibility to advise our clients on what to do based on what’s in their best financial interests, regardless of how we as a business are impacted.

With this in mind, it may be prudent for some of our readers not to invest with us—at least not just yet.

So, where to start? You can follow our five-step action plan to develop a solid debt payoff and investment strategy.


Our 5-Step Action Plan:

  1. Always Make Your Minimum Debt Payments on Time
  2. Take Advantage of Your Employer-Sponsored Retirement Plan
  3. Pay Off High-Cost Debt
  4. Build Your Safety Net
  5. Save for Retirement

1. Always Make Your Minimum Debt Payments on Time

First things first: You should prioritize paying at least the minimum amounts due on your required debt payments on time. Not doing so can lead to penalties, extra interest, and higher finance charges, in addition to ruining your credit score. Negative information, such as excessively late payments or collections, generally stay on your credit report for up to seven years.

If you are having trouble staying current on all of your debts, consider consolidating or restructuring to make your payments more manageable. Also consider calling individual creditors to negotiate your rates and payments; you may be pleasantly surprised that your actions can result in more favorable terms.

2. Take Advantage of Your Employer-Sponsored Retirement Plan

Check to see if your company offers to match any percentage of your contributions to an employer-sponsored retirement plan, such as a 401(k). If it does, and you’re eligible to sign-up for the plan, then you should participate and take advantage of that free money.

Match programs generally work like this: Let’s say you’re participating in your employer-sponsored 401(k) plan by contributing 6% of your pre-tax income, based on an annual salary of $80,000.

After a year, you’ll have contributed $4,800 to your 401(k) account. If your employer offers a dollar-for-dollar match for up to 6% of your contributions (i.e., 100% match on the first 6%), then you’ll pocket an additional $4,800 just for participating, for a total of $9,600 in contributions for the year.

Any match is free money, and that return beats out many investment alternatives.

Keep in mind that matched contributions come in various shapes and sizes. Match formulas can even be tiered based on income and employee tenure, so check your company’s benefit guidelines regarding the relevant thresholds.

3. Pay Off High-Cost Debt

After continuing to make timely bill payments and evaluating your eligibility for matched retirement plan contributions, your third goal should be to pay off high-interest debt.

For most people, the most expensive debt is associated with credit card or unsubsidized student loan debt.

The average American has $4,400 in credit card debt and the average interest rate on those cards is around 15%. The graduating class of 2015 averaged $35,000 in student loan debt, more than any class in history.

This high-interest debt is an emotional burden and drag on your finances, which is why eliminating it from your balance sheet is a top priority.

At Betterment, we consider any debt costing above 5%* in interest or finance charge fees to be high-cost debt and it should be paid off before general investing. Others may use a higher number (e.g., 8%), but we take a more conservative view here.

So if you have debt that’s costing you over 5% in fees, pay it off as fast as you can. Start with the highest-interest debt first.

4. Build Your Safety Net

After your high-cost debt is gone, you should begin building a safety net fund for financial emergencies.

We recommend saving three to six months of living expenses, including your monthly housing payments, bill payments, utilities, and other recurring monthly bills. A safety net can provide a financial buffer and prevent you from turning to your credit cards or tapping into your home equity for a line of credit when unexpected expenses occur. A safety net also provides some wiggle room in case your income is interrupted as a result of job loss or medical emergencies.

If you don’t have high credit limits or access to additional liquidity in the form of a line of credit from your home equity, you could consider building a starter safety net fund while paying off high-cost debt. After paying your regular bills, see if you have any cash left over to allocate toward a savings account. Any amount saved can go towards building a solid safety net fund.

5. Save For Retirement

With your high-cost debt eliminated and safety net in place, you are now ready to invest for the long-term.

By the time you reach 59½ years of age, or when you’re allowed to withdraw from your 401(k) penalty-free, that 401(k) match alone may be insufficient to support your post-retirement lifestyle. That’s why you’ll want to start saving for retirement early. Here are some points to consider:

  • How Much to Save: To get this number, you need to consider factors such as when you want to retire, your future Social Security benefits, inflation, taxes, and estimated investment returns.
  • Where You Should Save: To optimize to which accounts you want to direct your money, you should factor in your future tax bracket and investment account fees.

If deriving these numbers sounds like a complicated task, it’s because it is. That’s why we built our retirement planning tool, which can help tell our clients how much you need to save for a comfortable retirement. We take into account when and where you plan on retiring, as well as your current and anticipated income (for example, Social Security benefits).

Knowing how much you need and actually investing to reach that goal requires follow-through. Make investing for your retirement a priority and be careful not to sacrifice funding it through wasteful spending that can restart the debt cycle.

Prioritize What's Important

Balancing how to attack paying off debt versus investing requires prioritizing what’s important and putting your money to work as efficiently as possible.

Hopefully, Betterment’s steps have helped take the guesswork out of your action plan, so that you can start eliminating debt, benefitting from your retirement plans, building a safety net, and investing for retirement.

Of course, there’s no specific timeline to achieving these steps; that depends on your unique financial circumstances and priorities. However, we suggest you stay the course and be diligent with our five-step framework.

Get Started with Betterment

With a Betterment account, you can sync all of your accounts to make our five-step plan even easier to follow. You can easily sync your accounts (including savings accounts, retirement plans, and debts) to view all of your finances in one place.

If you’re a property owner, you can also add your real estate owned to get an even better sense of your overall wealth.This way, you can see as your net worth increase as you get closer to reaching your goals.

You’ll also want to complete your retirement plan, to understand how much you need to save for a more comfortable retirement. We make it easy to automate deposits, create new Individual Retirement Accounts (IRAs), or roll over existing retirement accounts.

We handle investments so you don’t have to, and we offer a globally diversified portfolio of index-tracking exchange-traded funds (ETFs), with personalized advice in a goal-based investing framework. With powerful tax efficient features such as tax loss harvesting, everything we do is designed to help you save money on taxes while you’re investing for your long-term investing goals.

Get started today.


*From 1928-2015, the U.S. stock market has returned an average of 9.5% per year. However, that return is not guaranteed and fluctuates from year to year. When you pay off your high-interest debt, that interest savings is guaranteed. It is the guaranteed savings that makes paying off debt so attractive, even if the rate is slightly lower than what you might expect from investing.