Are you inheriting money from a relative? Or receiving funds from a lawsuit? Or planning to be a lucky lottery winner?
Some clients recently inherited. That puts a new lens on their financial situation. Here are strategies to consider.
Assess if you should pay off debt. List your debt balances and corresponding interest rates. If the interest rate is high, consider paying the debt off. If it’s low, it may be smarter to invest the funds.
The second smart move is to replenish your emergency fund, if needed. You should be able to easily tap three to six months of living expenses. You can use quick debt such as credit cards for some of it, but you’ll want two months in cash or CDs.
Your third option is to contribute the maximum to a health savings account if your employer doesn’t and if you have a qualifying health plan. That’s $3,500 if single; $7,000 for families; add $1,000 if you’re 55+. Why? Do it for the tax deduction, which is above-the-line and still available to most. Withdrawals are tax-free if used for qualified medical expenses.
If you’re not yet retired, consider “tax-shifting” your portfolio.
Let’s say you’re contributing $3,000 to your 401k. You can increase that by $22,000, to the maximum, if you’re 50+. Since your paycheck decreases, your tax decreases. If your tax rate is 22%, you’ll only need $17,160 ($22,000 (1-22%)) from your inherited account to reach the same spendable dollars. The tax-deferred account in your portfolio will grow faster while the taxable account shrinks. That minimizes taxes.
Deliberate your position on commingling.
Let’s say you and your spouse have a retirement portfolio. You inherit from your parent. You both can spend it now, perhaps on the house. Or this inheritance can let you both retire earlier. If you save the inheritance – separated in an account in your name alone – it remains your asset in case of divorce.
Most states would consider that non-marital and not subject to division between divorcing parties. Spending it together now or retiring early and spending that account down muddies those waters; you’re unlikely to recoup that.
If you have a new source of funds, rethink possibilities.
A client inherited funds from a parent two years ago. Previously they had withdrawn from IRAs to supplement income. Withdrawals from a taxable inherited account usually have low tax consequences. But on IRA withdrawals, every dollar gets taxed. If neither commingling and investment gains are issues, using the taxable account minimizes taxes and keeps your tax-deferred accounts larger longer.
The best tip? Avoid the spending spree.
Most people have not saved enough to keep spending at the rate they’re spending. We calculate how much clients can spend each year to use the last dollar on their last day. It seldom meets expectations. Common withdrawal rates are 4% to 5% of the balance.
Finally, if you have never handled sizable funds, interview at least three financial advisers, check references and hire one. Use their expertise well.
Sandi Weaver is a Certified Financial Planning professional and member of the Financial Planning Association of Greater Kansas City. She provides financial planning through Weaver Financial in Mission, KS. Weaver also works on the Wealth Management Committee in the Missouri Society of CPAs.