Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.
What is inheritance?
Inheritance is simply the act of coming into possession of property, or else the property that is given to you. When most people think of inheritance, more emotionally charged issues come to mind -- what our parents leave us when they die.
Inheritance practices have changed over the ages. Around the year 1000, the Normans introduced the system of primogeniture, in which the oldest son inherits everything, a tradition which dominated Western society for nearly a millennium, up until the days of the French and American revolutions. Luckily for the vast majority of us, primogeniture has given way to a more equitable tradition in which parents generally divide their estate equally among male and female siblings, with occasional threats to disinherit various ones should they get tattoos or lip piercings.
What to do with inheritance money
The best things you could do with inheritance money are the exact same things you should do with any large chunk of money that comes your direction. You first must pay off your debts, especially credit card debts. Financially, credit card debt is like carrying around a rotting albatross carcass around your neck; the 14% or so APR you’re likely paying on that debt will outpace any investment you could think of. Free yourself of that stinky dead bird!
It's important to know your goals before you invest as they dictate where you should put your money. If paying off debt is not one of those goals, you have a bunch of great options:
Buy a house: Though you might be able to find a bank that will loan you more, it’s inadvisable to take a mortgage loan for more than 80% of the home's sale price. For many, an inheritance may be the only way to come up with the necessary 20% down payment. There are some rent-don't-buy evangelists out there who swear that home ownership isn’t the best investment a person could make because home prices in the last quarter century haven’t been as robust as stock market gains, but other smart folks see it as a pretty effective way for regular folks to amass a million dollars. If you aren’t a particularly disciplined saver or regular investor, a mortgage may represent a forced savings plan for you, and it’s hard to quantify the sentimental value of a home of one’s own if you plan to raise a family.
Put your kids through college: University tuitions are rising everywhere, and many parents would prefer to jettison their chicks from the nest free of student loan debts, so financing education is a great gift that many wouldn’t be able to make without an inheritance.
If you do plan to fund your kid or kids’ education with an inheritance, invest as much as possible annually in your state-sponsored 529 plan, which will not only allow the investment to grow within the account tax-free, your state may also offer other tax breaks on contributions. Some states’ plans are better than others.
Invest it: The absolute best way to turn a small inheritance into something that will support you when you’re old — and even provide an inheritance for your kids or a beloved Maltese — is through investing. There are many things that could happen that could disrupt the global economy in the future, and past results should never be understood to be any type of guarantee, but rather imperfect predictors of future performance. That said, if you crack open any history book, you’d see that between the years of 1950-2009, the stock market grew by 7% per year. So, using a compound interest calculator like this one, you'll see that had you invested a $50,000 inheritance during a period of average growth, the miracle of compounding would have turned that $50,000 into about $71,000 in five years, $100,000 in ten years, and about $202,000 in twenty.
How to invest an inheritance
You know what’s great about investing? You only have to learn how to do it once, and after that, any money that comes your way, be it inheritance, bonus, or the monthly $200 dollars earmarked for your retirement, can all be invested in a similar way. If you’re looking for a deeper dive on the intricacies of a smart investing strategy, you’d be well served spending a few minutes over here, but in a nutshell, open a personal investment account and keep the following in mind.
Take advantage of all available tax breaks
Think of your inheritance as one of those fabulous champagne towers that you’ve never actually seen at any wedding you’ve personally attended. The top cups always get filled first before anything below gets even a drop of champagne. Pretend money is champagne. For any smart investor, those top cups that get filled first are tax-advantaged accounts, which will include a work 401(k), a traditional or SEP IRA, and/or a Roth IRA. The government has created these special tax-saving accounts to encourage its citizens to save for retirement and other major life expenses so you should absolutely fill them to the brim before considering investing money elsewhere. Otherwise, you’re walking away from free government money.
Keep fees low.
Fees are like investment vampires; left unchecked, they’ll suck every drop of gains in an account. Mutual fund management fees (MERs) may appear to be puny little numbers, but one Toronto-based investment advisor showed that a fee of just 2% could decrease investment gains by half over the course of 25 years. Your mission? Become the Van Helsing of fees. Find a low fee provider, that offers financial advice should you need it.
Diversify your investments
Ever hear the expression about putting all your eggs in one basket? It’s just as true for investments as it is for fragile, hen-laid breakfast proteins. You should be invested diversely in various sectors, primarily stocks, and bonds, but also within each sector you should be invested diversely in various stocks and various bonds. The absolute simplest, cheapest way to achieve broad exposure into stocks, bonds, real estate, even the burgeoning marijuana market, is through exchange-traded funds, or imps. One price could buy you, for instance, a tiny sliver of the 500 most valuable companies on the stock market. A low-fee, quality automated investing service like Wealthsimple offers a wide variety of diversified portfolios for investments of any size from investors of all risk tolerances.
Invest in a passive portfolio
People who earn a fortune picking the stocks that go into mutual funds will swear that their expertise is well worth whatever fee you pay for it. Science begs to differ with their conclusions; most studies show that almost all actively managed funds will fail to outperform the overall market over the long term. A passive portfolio of ETFs—that is, investments programmed with an algorithm that simply tracks an entire economic sector or index, like the S&P 500—is a particularly smart, low-fee way to invest your inheritance. Even Warren Buffett, who became one of the richest men in the world by picking specific companies and stocks to invest in, has spent the last decades discouraging pretty much everyone not named Warren Buffet from trying to make money picking individual stocks. In fact, Buffett has encouraged his heirs to invest the lion’s share of their inheritance in low-fee, highly diversified stock funds.
When to invest inheritance
The stock market is by nature volatile. Though it’s historically gone up over time, there are occasionally deep market dips that can cause a lot of stress to investors. So, if you're investing a large chunk of money from an inheritance, is it smarter to go all in at once, or invest just a little at a time? The technical name of the little-at-a-time strategy is dollar cost averaging, the hope being that by investing at regular intervals you’ll be buying at an average price, and avoiding overpaying for an investment that’s about to fall. Studies demonstrate that investing all at once is the superior strategy; historically, average one-year returns for the all-in investor would yield 12.2 percent versus 8.1 percent for the dollar cost average. Why? Because you stand to lose more in returns by having your money on the sidelines, trickling into the market than you do from the risk of a momentary dip in the value of your investment. But how much is peace of mind worth? Dollar cost averaging is a totally valid strategy, and it’s okay to sacrifice a few hypothetical bucks if tiptoeing into an investment will allow you to sleep better at night.
How to plan to a future inheritance
Before we start planning for an inheritance, a couple words of warning: exactly how much inheritances amount to is often a total mystery until a loved one dies. Naturally, their impending mortality is not exactly something you’ll want to broach with your folks over Christmas dinner, but it’s such an important topic it's truly worthwhile to figure out a quiet time to discuss it. Many people seriously overestimate the size of their parents’ estates. And it’s best not to make too many plans for the money that’s not yours yet; a recent study showed that a full third of those who received an inheritance blew through it within two years.
If your parents are wealthy, it may make sense for them to pass on some of their money while they’re alive, in order to avoid you owing taxes on it when they die. (When we say wealthy, we mean rich; as of 2018, in the US, any estate worth 11.8 million dollars or less is not subject to the federal estate and gift tax, though twelve states do assess estate taxes.) Every year, parents are permitted to gift up to $15,000 to each family member tax-free—up to a total of $150,000 in gifts. If they hope to help with your kids’ education expenses, it might make sense for them to deposit money into a tax-advantaged education account on behalf of your children. If your parents are really really wealthy—like if your dad is Bill Gates—or they don’t trust their heirs to spend their money wisely, they may consider putting their estate in trust, which offers some tax advantages and also makes arrangements for the estate to be managed by an independent third party, called a trustee.
Is a spouse entitled to inheritance money?
Imagine, you get a divorce. Sadly, it happens to the best of us. Will your ex be entitled to half of the inheritance your parents left you? The simple answer: no, your ex will not get his or her paws on that money because according to divorce laws, an inheritance is legally considered a “separate” asset, as opposed to a “marital” one, which would need to be divvied up according to state or provincial laws. That being said, there’s a great big asterisk on this statement: though the money may start as a separate asset, it remains separate only if it’s actually kept separate and segregated from other joint assets. If an inheritance is, for instance, deposited into a joint brokerage account, it’s now considered “commingled,” meaning it can no longer be considered separate property. What if an inheritance is used to pay for a vacation home? It’s commingled, and the house will be divided according to state or provincial laws. What if the inheritance was used to pay for a trio of adorable pugs? Those pugs are commingled, commingled, commingled and each spouse may well be entitled to a pug and a half.
How long does it take to settle an estate?
Don’t feel guilty. It’s only natural that you’d want to know when you’re actually going to receive your inheritance. So how long does it take to settle an estate? The dad joke answer: too long. Bad news: sending out checks is pretty must the last thing in a long list of stuff that gets done. How long it takes will depend on a lot of factors. Did dad leave a will? Did dad leave ten different wills that ten different siblings will fight over in probate court? Is the executor taking care of estate matters with the speed and urgency of a tree sloth? In other words, how long it will take to settle an estate is a matter that’s super case specific. A month? It will likely take longer than that. A year? It could certainly take that long. Five years? No, it probably won’t take that long.
Do I have to pay taxes on an inheritance?
The Federal Government will not tax you on an inheritance, though it will assess capital gains taxes on any estate property, like a house, or stock, that sells for more than its purchase price. Six states collect state inheritances taxes, so you might gently prod older parents to move to a sunny, tax-free state like Florida, rather than staying put in Iowa, Kentucky, Maryland, Nebraska, New Jersey or Pennsylvania, which all assess some kind of inheritance tax. (An inheritance tax is levied by the state where the estate owner resided, not where the beneficiary lives.) Though twelve states assess estate taxes, the federal government does not in most cases; as of 2018, only estates worth in excess of 11.8 million will owe federal taxes, so if you do end up owing the Federal government a few thousand, don’t expect to encounter too much sympathy from the lads at the corner bar.
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