One of the kindest gestures anyone can make is including someone in their will. Because it’s both an honor and a privilege to be on the receiving end, one should use what’s bequeathed to them wisely.
But too often that’s not the case.
On average, a third of inheritances are gone within two years. This is largely because people tend to look upon their inheritance as a windfall rather than as a sum that resulted from hard work and good money management. Such a mindset is unfortunate, since wise investments can help you, too, leave something for your progeny.
Here are seven ways you can invest your inheritance to help you build wealth.
Grieving a Loss
In some cases, inherited wealth can come with a sense of guilt — and pain. After all, it can seem as if the only reason you were left something is because someone you cared a great deal for died. This kind of emotional response to your inheritance can have a debilitating effect on your ability to plan and make decisions.
A healthier and more productive way to emotionally experience your bequest is to focus on appreciation rather than loss. Doing so can give you the peace and perspective you need to make the smart financial decisions your loved one would want. Further, you’ll be less likely to squander the money on frivolous purchases.
It is normal and perfectly fine to take some time to get used to the fact your loved one is gone before deciding what to do with their estate. In general, the wisest course of action is to use the cash to get you closer to financial freedom. After all, more than likely, that was the intent.
What Is Considered a Large Inheritance?
Going back to the early 1900s, inheritances have been the primary source of 60% of private wealth in the United States.
Because estates vary in size, what’s considered a large inheritance to some might be looked upon as a modest amount to others. With that said, the average U.S. inheritance is approximately $46,200, according to the Survey of Consumer Finances. The average bequest among the wealthiest 1% of households is upwards of $719,000, while the 9% below them average $174,200.
Overall, though, a bequeathal valued at $100,000 or more is widely considered a large inheritance. If you’ve never had command of such a sum, figuring out what to do with it can be intimidating.
A smart thing to do in such a situation would be to sit down with a fiduciary fee-only financial advisor to discuss how best to use the money. Rather than looking to them to tell you what to do, ask them about your options. Keep in mind that one of the first things you’ll have to deal with is taxes.
Your inheritance might subject you to certain tax liabilities, depending upon the types of assets your inheritance includes. It’s important to gain an understanding of these before you do anything else. Inheritance taxes may be applicable depending upon your state.
• Inheritance Taxes — Residents of Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania will be subject to inheritance taxes. Rules governing such assessments do vary by state, so it’s best to consult a tax professional familiar with the rules of your area. You’ll be responsible for paying taxes from your inheritance. There is no federal inheritance tax, so you’re safe there.
• Federal Estate Taxes – You may have to pay federal estate taxes on your inheritance, depending upon the value of the estate. As of this year, federal estate taxes are applied to bequeathals of at least $12.06 million. Bear in mind that this amount can change with each presidential election, so it’s a good idea to see what’s current when you’re reading this. Note that the tax is applied to the whole estate rather than to individual beneficiary amounts. Tax rates can be 40% or greater, so it’s a good idea to plan and do what you can to shield the assets as much as possible.
• IRA Inheritances – There may be other tax liabilities as well, depending upon the nature of the assets you receive. Withdrawals from standard IRAs will be deemed taxable income. However, Roth IRA withdrawals are exempt because the tax was paid when the money was deposited. There are also required minimum distribution rules to consider, depending upon your age. Again, the best play here is to consult a tax professional.
• Taxable Investment Accounts – Individual brokerage accounts can introduce tax liabilities as well. You’ll have to consider capital gains, dividends, and interest payments — all of which can incur taxes, based upon your income. Again, you’ll need to consult a tax professional to assess your situation and to plan accordingly.
• Life Insurance Benefits – These are typically tax-free but it depends on the nature of the policy. A universal life insurance policy carrying a cash value that has realized gains could trigger a tax liability. This is also true for a whole life policy that has been held for a long time.
The best approach here is to consult with a tax professional to see where you stand to avoid unpleasant surprises.
Managing Inherited Assets
Your first consideration should be your overarching financial goals. If you have yet to establish them, it’s now time to do so. Depending upon the amount of your inheritance — and your current financial situation — two of the smartest first steps are paying off debt and establishing an emergency fund of at least six months’ living expenses.
Setting up a college fund for your children – if you have any, that is, or are planning to — and beefing up your retirement savings are the next two moves you should make. This is also a good time to buy a house if you don’t already own one.
Speaking of which, you might also inherit a house or other real estate holdings. If a house is among your inheritance, your choices are to live in it, rent it or sell it.
• Selling will net you a sizable amount of cash, with which you can make other investments, minus the amount you’ll pay in taxes.
• Renting will set you up with a passive income stream, which can also help you diversify your investments. Yes, you’ll encounter property tax as well as maintenance concerns, but renting can still be worthwhile since the income you’ll derive could cover these costs, as well as any mortgage payment.
• Living in the property sidesteps the concerns of the other two actions, but you will be subjected to mortgage payments (if one is outstanding), property taxes, and maintenance costs.
Beyond that, it all depends on your personal goal. Put some thought into how you want your life to be 10, 15, 20 years down the road and use the inheritance to help you get there. This typically brings investments into play, so let’s look at some potential options.
Investing in Real Estate
Real estate has been the foundation of many a family fortune. The benefits of real estate investing include the ever-increasing value of your investment, which can be a strong hedge against inflation. Moreover, you can always adjust rents to keep pace with inflation.
You will encounter maintenance challenges and all the “people” issues that come with being a landlord. However, you can hire a property management company to free you of such burdens in exchange for a monthly fee. Another approach to investing in real estate is buying into a real estate investment trust (REIT). Doing so gets you the benefits of owning real estate without most of the headaches.
This can be a good way to attain long-term growth. A smart play here is to open a brokerage account with which you can purchase stocks, bonds, mutual funds, exchange-traded funds, commodities and the like. Industry competition has forced many brokerages to do away with trading fees. This will enable you to make moves without incurring crippling expenses.
Be forewarned, however, that investing in the stock market requires both patience and research. You’ll need to spend time familiarizing yourself with companies you’re interested in, as well as the industries in which they operate. Choose the stocks that make the most sense to you based upon your research. Then, hold onto them for years to benefit from their growth and the power of compounding interest.
Here, it’s key to remember the importance of diversifying your investments1 across a number of different companies in various industries to avoid placing all your proverbial eggs in one basket.
One way to simplify the process above is to go with mutual funds rather than individual stocks. Doing so gets you a professional portfolio manager who will make moves based upon their experience and expertise. The benefits of doing so include convenience, diversification, and automatic profit reinvestment.,Mutual fund investments tend to outperform individual stock investments because they are actively managed.
On the other hand, you’ll pay fees that can be quite excessive in some cases. Some mutual fund expense ratios can exceed 1% of the value of your portfolio. Sounds minimal? That 1% can add up quickly as the size of your fund position continues to grow each year.
You’ll also encounter tax events over which you’ll have little control when the fund sells securities and distributes the proceeds. Because that money is taxed at either the capital gains rate or the ordinary income rate, you could find yourself with an unexpected bill at year’s end.
These work much the same way as mutual funds, but with one important difference: whereas mutual funds are managed actively, index funds are designed for passive management. This can make index funds much more affordable to own since the fund manages itself based upon the movements of the assets it tracks.
This preselected collection of assets can be based upon a number of different factors. You’ve probably heard of the Standard & Poor’s 500 (aka the S&P 500), which is comprised of the stocks of 500 of the largest corporations in the U.S. Other index funds work in a similar fashion; they’re basically an amalgamation of stocks, bonds, or other types of assets into which your capital will be invested.
Your investments will then rise and fall with the values of the assets the index tracks. By the way, index funds tend to outperform professionally managed mutual funds. As of this writing (January 2022) the S&P 500 was showing a 13% one-year return. With that said, you do have to take care to select a high-performing index.
When it comes to diversification, including an array of alternative investments in your portfolio can be a good idea. Doing so can also give you the ability to earn passive income while protecting you from the ebbs and flows of the stock market. Alternative investment asset classes include real estate, shipping vessels, legal settlements, art, and financial instruments.
Until recently, investments of this nature were open only to high-net-worth individuals who met the criteria established for accredited investors. However, firms such as Yieldstreet offer managed funds of alternative investments to retail investors, giving everyone an opportunity to benefit from these potentially lucrative opportunities.
Yes, such investments can entail more risk than stocks and bonds and the like, but they can also provide an opportunity to realize more significant gains as well. You can learn more about alternative investing at the Yieldstreet website.
Understanding how to invest your inheritance to help build your wealth is key to providing a strong foundation upon which your family’s fortune can be built. Finding yourself entrusted with the fruits of a lifetime of labor and careful management should be looked upon as both an honor and a privilege.
It is critically important to resist the temptation to splurge on frivolities and instead maximize the value of the inheritance while minimizing the tax liability. Regardless of the size of the bequest, you’ll honor the memory of your loved one by doing everything possible to grow their legacy.
1. Diversification does not ensure a profit or protect against a loss in a declining market.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.