Is it difficult for you to imagine yourself suddenly and unexpectedly falling into a boat load of money? It happens more often than you think. You may not win the lottery but you could inherit a significant amount of money from a loved one.
Even if that isn’t on the horizon, it’s very likely that as a result of a work bonus or asset sale, you’ll find yourself with a lot more cash on your hands than you are used to dealing with.
If that happens, what should you do? Where should you turn first? Should all go into your emergency fund? Maybe. I can’t provide you with specific advice because I don’t know anything about your specific situation. But here’s a checklist to go through that will help keep you out of trouble and potentially shield you from making any non-reversible mistakes:
1. Take Care Of Any Tax Liability
When you inherit money you rarely have to worry about income tax. If there is an estate tax bill, the trustee or executor of the estate should pay those bills before making any distributions. Of course once the asset is in your name you’ll have to report any income and/or capital gains the asset generates and you may have to pay tax on that money.
If you inherited an IRA talk to your tax professional. You will only have to pay tax on money you withdraw from the IRA. If this is a spousal rollover, you may not have to take any distributions unless you are 70 1/2 or older. If this is a Beneficiary IRA you will have to take mandatory distributions and they are taxable of course unless we are talking about a Roth.
If the lump sum is from an asset sale or bonus payment, that might be taxable. It’s always best to check with your tax professional first. That’s the first call to make when something like this happens.
2. Debt
Once you’ve made sure that you aren’t on the hook for any tax liabilities as a result of this good fortune, it’s time to use these assets to their highest and best use. If you received cash, I recommend paying off any consumer debt you have. Even if you received non-liquid assets like a business or real estate, you might consider selling those assets if your consumer debt is high enough.
As an alternative, you might be able to refinance your debt now that your situation has improved so much. Don’t be complacent about your debt. It’s usually too expensive and it’s almost always good to get rid of it.
Just make sure that you if you have debt, you solve the underlying reason for it. It makes no sense to pay off a bunch of high-cost debt just to go right back and run up more credit card bills.
This often happens to people who are suddenly flush with cash. They make the mistake of thinking they can never run out of cash. That’s not true. Just ask the rich and famous who are now famously broke. Consider your windfall a wonderful opportunity to get back on the right path if you have debt.
Extinguish the debt and make sure you won’t run into the same problem down the line. You might have been really fortunate to find yourself with this unexpected windfall. Don’t push your luck by blowing it all.
3. Goals
Your next maneuver after taking care of any consumer debt is to build yourself a plan for the future. I know that money is burning a hole in your pocket but I strongly suggest that you cool your jets Pilgrim. There will be plenty of time to get that money working.
Take your time to learn how investments work – especially long-term investments. Next, identify your long term goals and build yourself a financial plan to help you achieve those goals. You can either run your own plan or find someone to help you. Either way, please don’t start investing without knowing how or why.
4. Invest
Now that you’ve taken care of your obligations, studied up on investing and created a plan, you are ready to put your money to work.
If you are a DIY investor, just start slowly. If you want to work with an advisor, take your time in deciding who you want to work with. There is no reason to rush either way. Take your time.
5. Enjoy
If you invest wisely, every dollar you invest means you’ll have several dollars to spend in the future. That’s great. But don’t forget about the present. Take a reasonable amount of money and enjoy yourself. If there is a trip you’ve always wanted to take, go take it. If there is something you’ve always wanted to own and now you have the money to buy it, go get it. Because you’ve already taken care of your obligations and put the appropriate amount of money to work towards your future, you will know exactly how much you can afford to spend now on something that is completely discretionary.
Twenty years ago I met a woman who inherited $200,000 and used every penny of it to remodel her home. At the end of the day she had a beautiful home but I’m not sure her decision was the best for her and her family. She carried $50,000 in credit card debt and didn’t have a dime saved for retirement. After the remodel was done, she still had the debt and nothing set aside for her future. Not pretty.
She spent that money because she wanted a nice house but she didn’t think about her overall situation and her other needs. If you were in her situation, what would you do differently?
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