If you’ve inherited money, start by knowing it takes a while for the money to land. The executrix needs time — months and months — to get things retitled. Then it takes time for the IRS or the state to release a lien or expedite an audit. Do NOT expect the money all at once.
While the estate is being settled, there may be income kicked off by the assets that have not yet been distributed. If the estate has to do its own tax return, then head’s up that you’re going to want to hire a CPA for this stage of your life.
Because when the estate does its tax return, it will send you a tax form called a K-1 that says how much of the estate’s tax you need to pay yourself. This is actually a *good* thing as your tax rates are almost certainly going to be lower than the estate’s. But it also means you have to wait to do your tax return until you get the K-1, and you need to expect you’ll have some taxes to pay. Check with the accountant doing the estate return for an idea of how to handle this.
Most estates will send you a chunk of money at the same time as they mail you the K-1 so you have cash on hand to pay the tax bill. (If you are the one settling the estate, then please get help if there’s more than about $20,000 in an IRA!)Doing absolutely nothing with the money is often a good choice for at least six months. Do NOT pay off your student loans. Do NOT pay off your car loan. Do NOT pay off your mortgage! Instead, stick the rest of it in a savings account. Not even CDs. If you have an investment account already you can put it in a Money Market fund. If you’ve inherited life insurance money, letting them hold it in a savings account for you is often a good option as their savings accounts often pay unusually high rates for cash.
7 Things to Do Before You Invest
There are a few steps to take before the right answer for what to do with the money emerges.
1. Do you have a “rainy day” fund? That is money set aside as the base in your banking system to handle intermittent things that will happen, like car repairs? This isn’t saving to be virtuous. This is to cover stuff that happens but not monthly: summer camp for kids, Christmas, semi-annual tax bills. Fluff up your bank accounts so the amount you have on hand is bigger. A larger pad makes the road of life less bumpy. (Note that your budget should be adding to this each month; 1/12th of your Christmas fund should go in there each month, for example, or 1/12th of the expected car repair bill. It’s just that it’s nicer to refill this base once you’ve established it. This is also a good moment to get started with YNAB or Buckets.
2. If you just happen to have recently run up some credit card debt, for example, from plane trips or time off of work associated with your loved one passing, go ahead and pay it off now. But if it’s old debt, stop a moment (see below.)
3. If you’ve got a large amount of debt and you didn’t inherit very much, a good strategy might be to ask the credit card companies to accept a settlement. Let’s say you owe $10,000 on a credit card and you’re just not ever going to be able to pay it. You can offer them $2000 as a one-time payment from this inheritance. They may very well accept that deal. Consult a credit counseling agency before you attempt this one.
4. Same as above but for IRS debt: the IRS will almost never accept an offer in compromise, but the exception is when you’ve just received what inheritances you might ever get and have no prospects of ever having a change in fortune. Contact a CPA or tax attorney that specializes in IRS Offers in Compromise to help you with this.
Okay, so now we start that six-month clock. I want you to do a few things.
5. Figure out how much money you spend each month. What’s the monthly nut you have to cover? Set aside 3 to 6 month’s “emergency money” (3 months if you’re married and both work, 6 months if there’s only one earner in the family.)
6. Figure out where you’re going to have investments. If you’re talking about less than $50,000 then you’re in the land of the do-it-yourselfers or the commission-based Main Street firms. If you’re a do-it-yourselfer I recommend reading the Bogleheads forum for a while. If you’re someone who always hires someone, see if you can find someone who is fee-only and hourly: the Garrett Planning Network is a good place to look. If you’re talking over half a million or so in investments, then you’re a good candidate for a CPA/CFP combination like you’ll find in the Alliance of Comprehensive Planners. In between, well, it depends. Just know that the Main Street firms take about 6% as a commission when they invest your money. If you’re investing $100,000 that’s $6,000. That would hire a great planner in the XY Planning Network. If there’s a bunch of IRAs involved you might prefer someone in ACP to manage the tax implications. See an article I’ve written on what to look for in a financial advisor.
7. Figure out your goals. What do you want to be able to do? How do you want to feel? Don’t say “I want a beach house”, say, “I wish to belong to a community that lives by the rhythm of the tides and ferry boats and smell the ocean spray every day.” Don’t say “I want to pay off my mortgage,” say “I want to feel the freedom of not having as big a nut to cover each month so I can pick or choose jobs I want to take.” Don’t say, “I want to buy a condo near my daughter,” say “I want easy access to my grandchildren so I can provide sick-day childcare and be at all their games.” Don’t say “I want to endow my alma mater,” say “I want to feel like I made a difference with my time on the planet by funding the things I value.” Don’t name the solutions yet, just dwell in the way you want to FEEL, what you’d like to be ABLE to do.
Now we’re ALMOST ready to invest the money.
There are three different dimensions to investing
Who is the custodian? Is it a bank, an investment company, an insurance company? My suggestion is to use an investment company as banks and insurance companies have higher fees and lower returns. Usually your choice of investment advisor will dictate who the custodian is based on their relationships, but you need to know that your money could be in any of these sorts of platforms.
How is the money titled? If you do it right, you’ll have inherited IRAs, IRAs of your own, and probably some taxable accounts that might be owned individually, jointly, in Transfer on Death (TOD) form or in trust (once you’ve done your own estate planning.) The best thing to fill up first, whenever you’re eligible, is an HSA, then a Roth. After that it depends more on your situation. The investment advisor can help with this, or you can read up on the options yourself.
How is the money invested? This comes dead last. It has to, because everything else takes a bunch of time.
3 Ways to Invest
Okay, NOW you’re ready to invest the money. You need to know that we consider investments in three pieces:
8. Money for unknown things a long time from now. Think of this as crops growing in the field. If I know nothing else about someone, I invest this in the Vanguard Wellington Fund or the Vanguard Balanced Index Fund. Either is a great set-it and forget it fund. (This is an astonishingly hard sentence to write as there are a gazillion asterisks to add here – whole libraries of books have been written on this subject. If you were one of my people this is probably not what I’d do for you if you had over $100,000. But… then you’d be paying my fees as a CPA/CFP. For free advice, this is pretty great advice.)
9. Money for foreseeable things. The car you’re going to buy in 3 years, the money you’re going to be living on if you’re withdrawing $2,000/month… We put this in a bond ladder or a CD ladder or sometimes bulletshares ETFs. Just don’t have it in the stock market. Think of this as the kitchen garden in your yard. At Vanguard, I like the Vanguard Short-term Investment Quality Bond fund.
10. Short-term money. You know you’re going to use this, probably within the next six months. Think of this as the food in your pantry. This goes in a Money Market Fund. Do you lose out on investment returns? Sure! But while the stock market goes up OVER time, it doesn’t go up ALL the time. Buying some sense of security by having the cash you need soon in a secure place is well worth the lost interest.
As part of this process, I like to spend some time getting the financial architecture cleaned up: Do your IRAs have beneficiaries? Are your investment accounts linked to your bank accounts? Do you have a good password manager working (like Lastpass) and have two-factor authentication turned on? Do you have a few printouts of your own statements and printed copies of your OWN tax returns? Basically, can you leave things in good order for whoever comes after you? But that’s all for another day.