You just learned of the passing of a loved one. During this stressful and emotionally taxing time, you also find out that you’re receiving an inheritance. While you’re grateful for the unexpected windfall, knowing what to do with an inheritance can bring its own share of stress.
While the amounts vary greatly, the Federal Reserve Board’s Survey of Consumer Finances reports that an average of roughly 1.7 million households receive an inheritance each year. First words of wisdomâresist the urge to spend it all at once. According to a study funded by the Bureau of Labor Statistics, one-third of people who receive an inheritance spend all of itâand even dip into other savingsâin the first two years.
Not me, you say? Still, you might be asking, “What should I do with my inheritance money?” Follow these four steps to help you make smart decisions with your newfound wealth:
1. Take time to grieve your loss
Deciding what to do with an inheritance can bring with it mixed emotions: a sense of reprieve for this unexpected financial gain and sadness for the loss of a loved one, says Robert Pagliarini, certified financial planner and president of Pacifica Wealth Advisors.
During this time, you might feel confused, upset and overwhelmed. âA large inheritance that pushes you out of your financial comfort zone can create anxiety about how to best manage the money,” Pagliarini says. As an inheritor, Pagliarini adds that you may feel the need to be extra careful with the funds; even though you know it is your money, it could feel borrowed.
The last thing you want to do when deciding what to do with an inheritance is make financial decisions under an emotional haze. Avoid making any drastic moves right away, such as quitting your job or selling your home. Some experts suggest giving yourself a six-month buffer before using any of your inheritance, using the time instead to develop a financial plan. While you are thinking about things to do with an inheritance, you can park any funds in a high-yield savings account or certificate of deposit.
âA large inheritance that pushes you out of your financial comfort zone can create anxiety about how to best manage the money.â
2. Know what you’re inheriting
Before you determine the things to do with an inheritance, you need to know what you’re getting. Certified financial planner and wealth manager Alex Caswell says how you use your inheritance will largely depend on its source. Typically, Caswell says an inheritance will come in the form of assets from one of three places:
Real estate, such as a house or property. As Caswell explains, if you receive assets from real estate, you will transfer them into your name. As the inheritor, you can choose what to do with the assetsâtypically sell, rent or live in them.
A trust account, a legal arrangement through which funds are held by a third party (the trustee) for the benefit of another party (the beneficiary), which may be an individual or a group. The creator of the trust is known as a grantor. âIf someone inherits assets through a trust, the trust documents will stipulate how these assets will be distributed and who ultimately decides how they are to be invested,” Caswell says. In some cases, the assets get distributed outright to you; in other instances, the trust stays intact and you get paid in installments.
A retirement account, such as an IRA, Roth IRA or 401(k). These accounts can be distributed in one lump sum, however, there may be requirements related to the amount of a distribution and the cadence of distributions.
When considering things to do with an inheritance, know that inherited assets can be designated as Transfer on Death (TOD) or beneficiary deeds (in the case of real estate), which means the assets can be transferred to beneficiaries without the often lengthy probate process. An individual may also bequeath cash or valuables, like jewelry or family heirlooms, as well as life insurance or stock certificates.
Caswell says if your inheritance comes in the form of investment assets, such as stocks or mutual funds, you’ll want to think of them as part of your own financial picture. âAll too often, we see individuals end up treating inherited assets as a living extension of their passed relative,” Caswell says. Consider how the investments can be used to support your financial goals when thinking about things to do when you get an inheritance.
An average of roughly 1.7 million households receive an inheritance each year.
3. Plan what to do with your financial gain
Just like doing your household budgeting, it’s important to “assign” your inheritance to specific purposes or goals, says Pacifica Wealth Advisors’ Pagliarini. Depending on your financial situation, the simple concepts of save, spend and give may be a good place to start when deciding on things to do when you get an inheritance:
Bolster your emergency fund: You should have at least three to six months of living expenses saved up to avoid unexpected financial shocks, such as job loss, car repairs or medical expenses. If you don’t and you’re deciding what things to do with an inheritance, consider parking some cash in this bucket.
Save for big goals: Now could be a good time to boost your long-term savings goals and pay it forward. Things to do when you get an inheritance could include putting money toward a child’s college fund or getting your retirement savings on track.
Tackle debt: If you’re evaluating what to do with an inheritance, high-interest debt is something you could consider paying off. Spending on debt repayment can help you save on hefty interest charges.
Reduce or pay off your mortgage: Getting closer to paying off your homeâor paying it off entirelyâcan also save you in interest and significantly lower your monthly expenses. Allocating cash here is a win-win.
Enjoy a little bit of it: It’s okay to use a portion of your inheritance on something you enjoy or find rewarding. Planning a vacation, investing in more education or paying for a big purchase could be good moves.
Donate funds to charity: Thinking about your loved one’s causes or your own can continue legacy goals and provide tax benefits.
When deciding what to do with an inheritance, taxes will need to be considered. “It is extremely important to be aware of all tax ramifications of any decision around inherited assets,” Caswell says. You could be required to pay a capital gains tax if you sell the gift (like property) that was passed down to you, for example. Also, depending on where you live, your inherited money could be taxed. In addition to federal estate taxes, several U.S. states impose an inheritance tax and/or an estate tax.
Since every situation is unique and tax laws can change, when considering things to do with an inheritance, consult a financial advisor or tax professional for guidance.
Make your windfall count
Receiving an inheritance has the potential to change your financial picture for good. When thinking about the things to do when you get an inheritance, be sure to give yourself ample time to grieve and to understand all of your options. Don’t be afraid to lean on the experts to get up to speed on any tax and legal implications you need to consider.
Planning can go a long way toward making the right decisions concerning your newfound wealth. Being responsible with your inheritance not only helps ensure your financial future, but will also honor your loved one’s legacy.
The post 4 Smart Things to Do When You Get an Inheritance appeared first on Discover Bank – Banking Topics Blog.
If you get paid every two weeks, you’ve probably noticed extra money coming your way certain months. Maybe you even thought your company’s payroll made a mistake! But it’s no mistake. You get two magical months like this a year: when you suddenly have a third paycheck andâthe best part isâyour monthly bills stay the same. Yes, it’s appropriate to jump for joyâprovided you have a plan for that extra income.
Why does this happen in the first place? If you’re paid biweekly, you get 26 paychecks throughout the 52-week year. That means two months out of the year, you end up getting three paychecks instead of your regular two.
Those two extra paychecks can go a long way. But without a plan in mind, they can also disappear. Fast. The first budgeting trick to saving two paychecks is to find out when they will hit your account. Grab a calendar and write down your paydays for every month in a given year and highlight the two extras. Maybe even put calendar reminders in your phone so you can track when the additional funds will hit your account. The extra paychecks will fall on different days every year, so tracking them in advance is key.
Samuel Deane, a founding partner of New York City-based wealth management firm Deane Financial, says there isn’t one correct way to budget with an extra paycheck, but that it should depend on your personal situation and financial goals. You could decide to give yourself some extra room in your budget throughout the year, for example, or use the extra money for something specific.
How can I budget for an extra paycheck? Consider these 5 budgeting hacks if you’re paid biweekly:
1. Pay down (mainly) high-interest debt
Once you’re done jumping for joy at the realization of the third paycheck, consider how your budget with an extra paycheck could help you pay down debt. “The first thing I usually tell my clients is to get rid of high-rate debt, which is usually credit card debt,” Deane says.
Before paying off debt with your new budget with an extra paycheck, make a list of all of your debts organized by balance and annual percentage rate (APR). Paying off the debt with the highest APR could save you the most money because you’re paying the most to carry a balance. Paying down a few low-APR, low-balance debts can also help you gain momentum and bring other financial benefits. For instance, if you owe close to your credit limit on a credit card, the high credit utilizationâor card balance to credit limit ratioâcould negatively impact your credit score.
If your budget with an extra paycheck includes debt repayment, you’ll start to owe less and have less interest accruing each month, freeing up even more cash from subsequent paychecks.
“The first thing I usually tell my clients is to get rid of high-rate debt, which is usually credit card debt.”
2. Build an emergency fund
Paying down debt isn’t the only way to budget with an extra paycheck. “Taking a look at whether you have a sufficient emergency fund is pretty important,” says Dan Stous, director of financial planning at Flagstone Financial Management.
An emergency fund of three to six months of your regular expenses can help you weather financial setbacks, such as a lost job or medical emergency, without having to take on new debt. Keeping these funds separate from your regular checking and savings accounts can help you keep them earmarked for the unexpected (and reduce the temptation to dip into them for non-emergency expenses). Places to keep your emergency fund include a high-yield savings account, certificate of deposit or money market account.
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If creating an emergency fund or adding to an existing one is on your to-do list, a budgeting trick to save two paychecks is to automatically transfer your extra paychecks into your emergency fund account.
3. Save for a big goal
If you want to save for a goal like a new car or home, or contribute to tax-advantaged retirement accounts, contributing two full paychecks out of 26 can be a good start. “If a client is debt-free and doing well, they might be able to focus on other goals,” Deane says. If you’ve got a financial goal in mind, a budgeting hack if you’re paid biweekly is to transfer your two extra paychecks from your checking account to a savings or retirement account right away.
If you have a 401(k) through an employer and already contribute enough to get your maximum annual match, Deane says you may want to consider a Roth IRA. A Roth IRA is for retirement, but it also allows first-time homebuyers who have held their account for at least five years to withdraw up to $10,000 to buy a home, Deane says. Your budget with an extra paycheck could then go to either major goal.
Even loftier, “you could put aside money to start a business,” Deane says. If you plan on starting a business someday you could put away the paychecks annually and let those savings build as start-up capital.
4. Get ahead on bills
If you already have an emergency fund, are currently debt-free and are making good progress on your savings goals, try this budgeting hack if you’re paid biweekly and get a third paycheck: Pay certain monthly bills ahead of time.
“If you have the ability to prepay some of your bills, it can ease anxiety in the coming months,” Deane says.
Before using this budgeting hack if you’re paid biweekly, check with your providers to confirm that you will not be met with a prepayment penalty, and get up to speed on any prepayment limitations. Some providers may even offer a discount or incentive if you pay something like a car insurance bill all at once. You could also explore whether or not prepaying your bills makes sense for utilities, your cellphone or rent.
If you’re looking for budgeting hacks if you’re paid biweekly, consider that managing money isn’t only about dollars and cents. Emotions often play an important part in personal finance, and they’re often the root cause of people’s decisions. Accepting this fact could be an important part of successfully managing your money.
“From an emotional and behavioral standpoint, people should reward themselves for being responsible,” Stous says. “Basically, treat yourself.”
Perhaps you need a vacation from the daily grind, want to enrich or educate yourself or your family or simply want to get a date night at your favorite restaurant on the calendar. A budgeting trick to save two paychecks could be supplemented with some spending on yourself.
“If you have an extra paycheck and a debt reduction goal, then maybe you apply the whole thing toward that goal. On the other hand, maybe you have a goal to retire in 10 years and you’re off track. Then, it’d be wise to put that money, or at least a portion of it, toward that goal.”
There’s no one-size-fits-all budgeting trick to save two paychecks
When you’re deciding how to budget with an extra paycheck, you might find yourself going back and forth between options.
“If you have an extra paycheck and a debt-reduction goal, then maybe you apply the whole thing toward that goal,” Stous says. “On the other hand, maybe you have a goal to retire in 10 years and you’re off track. Then, it’d be wise to put that money, or at least a portion of it, toward that goal.”
Even though budgeting solutions are not the same for everyone, being disciplined and proactive about the savings opportunity of a third paycheck can help you form a strong foundation for your financial future.
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