Inheriting Wealth: How To Invest

Inheritance is a complex and emotional process, and it's important to approach newfound wealth with caution and a clear plan. While it may be tempting to splurge on lavish purchases, seeking financial advice and understanding the tax implications are crucial steps.

The first step is often to take it slow and assess your financial situation, including any debts or emergency funds that need addressing. Once these immediate concerns are tackled, investing in stocks, bonds, funds, or alternative investments like real estate or cryptocurrencies can help build wealth.

It is also essential to understand the different types of inherited accounts, such as taxable accounts, retirement accounts, and trusts, as they come with varying tax implications and distribution rules. Seeking professional guidance from financial advisors, CPAs, and estate planning attorneys can help navigate these complexities.

Additionally, inheriting a house comes with its own set of considerations, including the option to sell, rent, or live in it, each with its pros and cons regarding taxes, maintenance, and emotional attachment.

In conclusion, while receiving an inheritance can be life-changing, it requires careful planning and professional advice to make the most of this opportunity and honour the legacy of your loved one.

Paying off high-interest debt

When it comes to investing an inheritance, paying off high-interest debt is often a recommended first step. This can include credit card debt, personal loans, or any other debt with a high interest rate. Here are some reasons why this might be a good idea:

Reducing the Cost of Debt

High-interest debt can be costly over time, with interest charges compounding and making it harder to get out of debt. By using a portion of your inheritance to pay off these debts, you can reduce the overall cost of the debt and the time it takes to pay it off.

Freeing Up Cash Flow

High-interest debt often comes with significant monthly payments. By paying off this debt, you can free up cash flow in your budget, giving you more flexibility with your money. This extra cash flow can be used to build an emergency fund, invest, or save for other financial goals.

Improving Your Credit Score

High-interest debt, especially credit card debt, can negatively impact your credit score. Paying off this debt can help improve your credit score, which can be beneficial when applying for loans or other credit products in the future.

Peace of Mind and Emotional Benefits

Carrying high-interest debt can be stressful and cause anxiety. Paying off this debt can provide a sense of relief and improve your overall financial well-being. It can also help you feel like you are honouring the legacy of the person you inherited the money from, as you are using it to improve your financial stability.

Tax Benefits

In some cases, there may be tax benefits to paying off high-interest debt with an inheritance. For example, if you live in a country where you can deduct the interest paid on certain types of debt from your taxable income, paying off the debt could reduce your tax burden. It's important to consult with a tax professional to understand the tax implications of your specific situation.

When deciding how to allocate your inheritance, it's important to weigh the benefits of paying off high-interest debt against other financial goals and priorities. It's also crucial to address the underlying causes of your debt to avoid falling into the same pattern in the future. This may involve creating a budget, increasing your income, or changing your spending habits.

Investing in stocks, bonds and funds

• Take it slow: When you receive an inheritance, it's important to take a slow and measured approach. Evaluate your current financial situation and prioritize how the inheritance is used. Pay off any high-interest debt, such as credit cards or personal loans, and consider building an emergency fund that covers at at least six months' worth of expenses.
• Get professional advice: Investing an inheritance can be complex and emotional. A financial advisor can guide you through the process, help you understand the tax implications, and create an investment strategy that aligns with your goals.
• Understand the tax implications: Inherited investments, such as stocks and bonds, have a stepped-up tax basis. This means that the cost basis changes to the price at the time of inheritance, allowing you to avoid capital gains taxes on the appreciation during the previous owner's lifetime. However, if you sell the inherited investments, you will be liable for taxes on any gains.
• Consider your risk tolerance: When investing in stocks, bonds and funds, it's important to consider your risk tolerance. If you are uncomfortable with high-risk investments, consider lower-risk options such as Treasury notes, high-quality corporate bonds, or money market funds.
• Use tax-advantaged accounts: Take advantage of tax-advantaged accounts such as IRAs, Roth IRAs, 401(k)s, and 403(b)s. These accounts offer valuable tax breaks on contributions or withdrawals, depending on the type of account.
• Diversify your investments: Diversifying your investments across different asset classes, such as stocks, bonds, mutual funds, and ETFs, can help reduce risk and improve long-term returns.
• Consider a brokerage account: A brokerage account offers flexibility, as you can add or withdraw money at any time without penalty. You can invest in a variety of assets, including stocks, bonds, mutual funds, ETFs, and commodities.

By following these steps and working with a qualified financial advisor, you can make the most of your inheritance and build wealth for the future.

Contributing to an IRA

An Individual Retirement Account (IRA) is a tax-advantaged account that allows individuals to save for retirement. There are two main types of IRAs: traditional IRAs and Roth IRAs. Both types of IRAs have different tax implications for contributions and withdrawals.

When you inherit an IRA, it becomes what is known as an inherited IRA or beneficiary IRA. The rules for handling an inherited IRA differ depending on whether you are the spouse of the original owner or a non-spouse beneficiary. It's important to note that you cannot make additional contributions to an inherited IRA.

Rules for Spouses

If you are the spouse of the deceased original owner of the IRA, you have more flexibility in how you handle the inherited IRA. You can:

• Roll over the IRA into your own existing IRA. This allows you to defer required minimum distributions (RMDs) until you reach the age of 73.
• Set up a separate inherited IRA account in your name.

Rules for Non-Spouse Beneficiaries

If you are a non-spouse beneficiary, you cannot treat the inherited IRA as your own. You must set up a new inherited IRA account unless you want to distribute the assets immediately through a lump-sum payment. You cannot make additional contributions to the inherited IRA.

Additionally, the Setting Every Community Up for Retirement Enhancement (SECURE) Act mandates that non-spousal beneficiaries must withdraw all funds from an inherited IRA within 10 years of the original owner's death. However, there are some exemptions to this rule, including minor children, disabled or chronically ill individuals, and individuals who are not more than 10 years younger than the deceased.

Tax Implications

The tax rules for inherited IRAs depend on whether it is a traditional IRA or a Roth IRA. For traditional IRAs, you will be taxed on distributions, just like the original owner. For Roth IRAs, your withdrawals are typically tax-free, but you are generally required to deplete the account within five years.

Seeking Professional Advice

Handling an inheritance, especially when it comes to IRAs, can be complex. It is recommended to seek professional financial or tax advice to ensure you understand the tax implications and make the best decisions for your financial goals.

Investing in real estate

Rental Properties

This option is suitable for individuals with DIY skills, patience in managing tenants, and time to dedicate to the endeavour. While financing can be obtained with a low down payment, substantial cash is required upfront for maintenance and to cover periods of vacancy or non-payment of rent. Once the property starts generating income, that cash flow can be leveraged to acquire more properties and build multiple income streams.

Real Estate Investment Groups (REIGs)

REIGs are ideal for those with some capital who want to own rental real estate without the hassle of managing properties themselves. They are similar to small mutual funds, where investors pool their money to buy or build rental properties. A company then collectively manages all the units, handling maintenance, advertising vacancies, and interviewing tenants in exchange for a percentage of the monthly rent.

House Flipping

This strategy is for those with significant experience in real estate valuation, marketing, and renovation. It involves buying undervalued properties and selling them quickly for a profit. Flippers need to be able to accurately estimate repair costs, and those who hold onto properties for too long may incur snowballing losses.

Real Estate Investment Trusts (REITs)

REITs are best for investors who want exposure to real estate without making a traditional property transaction. They are corporations or trusts that use investors' money to purchase and operate income-producing properties. REITs are bought and sold on major exchanges like stocks, and they must pay out 90% of their taxable profits as dividends to maintain their status. As such, they are a solid investment for those seeking regular income.

Online Real Estate Platforms

Online real estate investing platforms allow investors to join others in funding relatively large commercial or residential projects. They provide an opportunity to diversify into real estate without a large financial commitment. However, many platforms are only open to accredited investors, and investments tend to be illiquid with lock-up periods.

Things to Consider

When investing in real estate, it is important to understand the different types of properties, such as residential, commercial, and land, and the zoning regulations that apply. Additionally, investing in real estate requires patience and a long-term strategy, as not all investments are low-risk. It is also crucial to do your due diligence and have a strong understanding of the market and investment properties.

Seeking professional financial advice

Receiving an inheritance can be a life-altering event, and it's important to approach this newfound wealth with caution and a clear plan. Here are some reasons why seeking professional financial advice can be beneficial when investing an inheritance:

• Expert Guidance: A financial advisor can provide expert guidance and help you navigate the complex world of investing. They will assist you in understanding the various investment options available, such as stocks, bonds, mutual funds, ETFs, and alternative investments like real estate or cryptocurrencies. By evaluating your financial situation, goals, and risk tolerance, they can create a comprehensive investment strategy tailored to your needs.
• Tax Implications: Understanding the tax implications of your inheritance is crucial. A financial advisor can explain the tax consequences of selling inherited investments, guide you through inheritance tax laws, and help you structure your investments in a tax-efficient manner. They can also advise on required minimum distributions and tax liabilities associated with inherited retirement accounts, such as IRAs.
• Debt Management and Emergency Funds: Paying off high-interest debt, such as credit cards or personal loans, is often a priority. A financial advisor can help you strike a balance between eliminating debt and building an emergency fund to cover unexpected expenses. They will ensure that you don't sacrifice long-term financial security while addressing your short-term needs.
• Wealth Management: A financial advisor can assist you in making informed decisions about how to spend, save, or invest your inheritance. They can provide strategies for wealth management, such as funding a family trust or investing for your children's education. By creating a solid financial plan, they can help ensure that your inheritance is used effectively and doesn't go to waste.
• Emotional Support: Inheriting wealth can be an emotional process, especially if it follows the loss of a loved one. A financial advisor can provide an objective, third-party perspective during this difficult time. They can help you make rational decisions by cutting through the noise and unsolicited advice you may receive from others.
• Retirement Planning: Navigating retirement accounts and their complex tax rules can be challenging. A financial advisor can help you understand the rules and requirements for inherited retirement accounts, such as IRAs. They can devise a withdrawal strategy that minimizes taxes and avoids potential IRS penalties. This is especially important if you inherit an IRA from a non-spouse, as the rules and timelines for distributions differ.

When choosing a financial advisor, look for a fiduciary who is legally bound to act in your best interest. Opt for a fee-only advisor to ensure unbiased advice, and consider their qualifications, experience, and fee structure. Remember, seeking professional financial advice can provide you with the knowledge and confidence to make informed decisions about your inheritance.

Frequently asked questions