Handling a Small Inheritance

How to handle a modest windfall

The chances are pretty good that at some time during your adult life, you'll inherit a respectable sum of money. It won't be enough to retire on, but more than you might spend on a family vacation to Disneyland. A bequest from your parents or grandparents will be money you'll want to do right by. This type of legacy is often a gift of love and in the midst of your loss, you'll want to create value with it.

An inheritance or bequest is often a windfall. Even if you think you'll inherit something, you won't know how much until you receive it. There has been much written in the last ten years or so about the huge transfer of wealth that will take place as the "greatest generation" passes their legacy to their boomer offspring. Those predictions were made in the heady 1990s when the stock market was going strong before dot coms imploded messily all over the US economy. The investments of many retirees took huge hits.

We enjoy our parents living longer, but at higher cost because few of us are able to care for them at home. Assisted living helps, but at dearer cost. Healthcare costs continue to climb into the stratosphere. As a result, the majority of us are likely to see trimmed estates as resources are used to keep family seniors warm, safe, and comfortable in their retirement years.

Nevertheless, many people want to leave bequests to children and grandchildren if they can. If you are fortunate enough to receive a modest sum, the following suggestions might help.

Do nothing

Depending on the amount, some financial advisors suggest doing nothing with the money for three to six months. Put it into low risk Treasury bonds, CDs, or money market funds and let it sit—collecting interest—while you ponder your goals. (Just make sure that the vehicle you choose, pays a higher interest rate than the current level of inflation.) The larger the sum, the more important this step.

Instead, make a plan. List your financial goals and how this money can help you achieve them. Look at your taxes for last year and examine ways to increase your savings and retirement funds and reduce your taxes at the same time. Ultimately, whatever you choose to do, try to make your money work on multiple levels whenever possible.

Put money into an IRA, 401K, or both

If you are like many Americans, your retirement savings aren't on track. Much has been written about taking advantage of tax deferred retirement savings plans. Take advantage of as many of these options as possible. A certified financial planner can help you formulate your retirement goals and calculate how much to contribute to each account to meet them. Other vehicles like educational and health savings accounts are additional avenues for enhancing your bottom line in the long term.

Pay off credit cards and loans

If you have credit cards or loans, now is the time to pay off as much as you can. Whether you owe $2000 or $20,000, those high interest rates add up over a year. Time to get that monkey off your back.

Start with the highest interest rate loans first. Pay them off in full if you can. For each credit card you pay off, discipline yourself to save the interest. Set up an account and have that part of your paycheck deposited directly to the new account. Finally, cut up the card and refrain from making any new credit card purchases unless you can pay the bill in full every month to avoid interest charges. Lenders consider such customers "dead beats" because they are using the credit to their advantage. It's an acquired skill, but worth the discipline.

Student loans can be paid off more slowly especially if you were able to consolidate loans at low interest rates. For example, if you can get a six-month CD at 5% interest, it doesn't make sense to pay off a student loan with an interest rate of 3%. Invest your money and continue to pay your student loans according to schedule.

Should you pay off the mortgage or home equity loan?

Your home is probably your largest single asset. Many of us have acquired second mortgages or home equity loans for improvements or other expenses. If there are no pre-payment penalties, it might be worthwhile paying off a second mortgage or home equity loan if the interest is high.

You can pay off your home entirely, but don't pay down an existing mortgage. In case of job loss or health emergency, your resources could easily be tapped out. Your loan amount may be reduced, but unless you refinance, you could have the same payment and no additional resources in a crunch. It's called painting yourself into a corner.

Consider the value of your interest deduction on your taxes too. It could be more to your advantage to keep the mortgage, especially if you purchased or refinanced in the last couple years when rates were at 50-year lows.

Invest in your home

Make improvements to your home that simplify your life and conserve resources. Increasing insulation and adding a heat pump can reduce your energy bills, help the planet, and keep money in your pocket instead of flying up the chimney. Take advantage of Federal and state tax rebates and conservation programs through local utilities to increase the value of your home. For many of us, home improvements require financing and credit, but if you can do it without borrowing, you stand to save a considerable amount of money.

Kitchen and bathroom improvements can net big gains if moving is in your plans. As long as you make cost-effective improvements that are appropriate to the home and its character, you can recoup your investment and even make a profit. Landscaping can ease maintenance burdens and provide curb appeal.

Organizational improvements that simplify your daily activities can also save you time and money.

If your home needs TLC to retain or increase its value, it could be a wise investment. If you want to add expensive granite to a home in a neighborhood of laminate countertops, you might want to rethink the potential return on investment.

Build a CD ladder

Most of us know that we should have liquid assets that can be tapped in case of emergency. Many financial consultants recommend readily accessible savings for living expenses that can tide you over three to six months. Given household expenses for the typical family of about $3000 a month, you would need to have $9–18,000.

Savings accounts are not very useful and don't pay an interest rate that even begins to cover inflation. One simple solution is to create a CD ladder. Buy a series of CDs that mature at different times, then roll them over as they come due if you don't absolutely need them. If you plan it out, you could have one maturing every month or every quarter, available for contingencies but not for squandering.

Enhance your education

Taking classes to increase your skills or knowledge is always a good idea. By allocating money for education, you could finish a degree or certificate program that allows you to go farther in your field or switch entirely. Over time, you can substantially increase your earning power.

Allocate money for fun

Again, depending on the amount, you can probably allocate 5–10% for fun. Take a vacation or buy a new toy, but be strict about where to draw the line. It's incredibly easy to feel like you have more money than you really do.

 Web Demesne
Support Demesne through our Bookstore