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Of all the money that may pass through your hands during your lifetime, none is more emotion-laden than an inheritance. After all, you got it because somebody died.
And the person who left you this inheritance may have explicitly or implicitly left strings attached: how to invest it, how to live your life, who to use as an adviser and maybe even what you can do in your career.
If the inheritance was unexpected, or large compared to your lifestyle, one common reaction is to go on a spending spree. Before you head off to Saks Fifth Avenue, assess your financial situation. Here's how:
- Figure out exactly what you have and what you're owed.
Typically, you don't just receive a check from the executor of the estate; you get bits and pieces of different investments. The good news: Usually, you get a "stepped-up basis," meaning that the cost-basis of the assets are determined as of the date of death. So even if your father bought stock in IBM when it was $5 a share, if it was worth $125 a share when he died (and after multiple stock splits), your cost-basis is $125. If you sell the stock at $130 a share, your capital gain is only $5.
You also won't necessarily get all of the assets at the same time. Getting different bits and pieces of your inheritance at different times is confusing, and it makes figuring out what you have all the more difficult. But you must know how much your inheritance is, how it is invested and what the cost-basis is to make good decisions going forward. You also need to know where the money is coming from. For example, if you inherited an Individual Retirement Account, there are major tax implications depending on how you decide to withdraw funds from the account. You also need to evaluate survivor insurance benefits, disability insurance benefits, Medicare and other policies if you're the only heir and file the appropriate claims for payment. Don't look at these as handouts. It's your money. Ask for it.
- Make a list of your short-term and long-term goals.
Assign dollar amounts to each goal and then compare your inheritance with how much you'll need to meet your goals. This is a real wake-up call, because when you get a chunk of money, it is very tempting to spend it on short-term goals such as remodeling the kitchen, buying a new car or sending children to private school. The problem: Most of us are going to have difficulty meeting long-term goals such as retirement and education for our children, and an inheritance may be the only way we can achieve them. Writing down those long-term goals next to the more immediately rewarding short-term ones gives them a fighting chance to get some of your inheritance.
- Decide how much you're going to use for a splurge.
OK, now that you know that you can meet your long-term goals, you can set aside money for that luxury cruise or new car. Set up a separate bank account for this money, and when it's gone, that's it -- no dipping into the rest of the inheritance.
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Invest this money in certificates of deposit, money market funds or even a savings account. This is money that you plan to spend in the near term, so keep it in low-risk, easily accessible accounts.
- Set aside three to six months' worth of your regular expenses in an emergency fund.
If you don't already have one, this is important. This also should be put in a short-term, fixed-income investment such as a money-market account.
- Establish an investment strategy for your long-term goals.
The rest of your inheritance is your long-term goal money and, if you're fortunate, it will go a long way to make up much or all of any shortfall you would otherwise have. You can use one of the investment strategies suggested here at MSN Money, in such places Jon Markman's SuperModels column or Jim Jubak's 50 Best Stocks in the World. Or you may decide that you need professional assistance.
If you received a sizable sum for your inheritance, you may be tempted to chuck the working life and live a life of "inherited wealth." Before you do that -- or make any other major financial or life decision -- consult a financial planner or use one of the personal finance software applications such as Microsoft Money to calculate how long the money would last.
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