According to Northwestern Mutual, $90 trillion will transfer to younger generations in the coming years [1].
That’s a lot of money and it will be important for those who receive a share of it to make smart choices. According to the survey, among those expecting to receive an inheritance, half (50%) consider it “highly critical” or “critical” to their long-term financial security.
Rebecca, 40, says she has inherited $3 million in stocks and $250,000 in cash, and has a $100,000 mortgage and $25,000 in other debt. What should she do with such a large windfall to make sure she’s using it wisely?
When you receive a large inheritance, the first thing to consider is the tax implications. Federal estate taxes don’t kick in until you inherit at least eight figures (the threshold in 2025 is $13.99 million), so you shouldn’t have to worry about that. Some states also impose an inheritance or estate tax (Maryland imposes both).
If you inherit assets you plan to sell, there’s good news. The step-up basis at death resets the cost basis for the inherited assets to the fair market value at the time of death. This usually helps reduce the amount of capital gains taxes you will owe.
Beyond the tax implications, you need to make a smart plan for how to make the money last. An often cited statistic from a 20-year study by The Williams Group of 3,200 families says that 70% of the time family wealth is lost by the second generation, and this number jumps to 90% for the third generation.
If you don’t want to become one of the majority who waste the funds, you should avoid jumping into spending the money or upgrading your lifestyle dramatically.
While it is probably a good idea to pay off your mortgage and other debt so you can avoid interest costs, you should refrain from doing things like immediately buying a bigger house or making other large purchases that eat away a big chunk of the money and require you to commit to higher ongoing expenses.
You should also avoid telling anyone other than your immediate family about the inheritance. If word gets out, you may find yourself targeted by people trying to get you to “invest” in their business venture, help them cope with “emergency” spending needs or any other excuse to access your funds.
The first thing you should do is pay off your debt and make sure you’ve built a sizable emergency fund, then invest every dollar, ideally in a mix of simple and safe investments.
You want to build a diversified portfolio, which means investing in a mix of different kinds of assets so you limit your risk of any one particular asset underperforming, and keep costs as low as possible.
Warren Buffett recommends that most people put 90% of their investment capital in an S&P 500 index fund, as this tracks around 500 of the largest U.S. companies and provides instant diversification since those companies are spread across all sectors of the economy. Buffett suggests putting the remaining 10% in short-term government bonds, which are fixed-income investments.
Read more: Rich, young Americans are ditching stocks — here are the alternative assets they’re banking on instead
You can also choose a different mix of assets. There are exchange-traded funds (ETFs) that track the performance of entire markets or sectors within them. For example, you could get broad exposure to a particular country or continent’s companies or bonds, or specifically focus on real estate, commodities, certain technologies or themes, dividend-paying companies or small companies.
You can talk with a financial advisor about asset allocation, or what percentage of your portfolio should go into these different investments, or you can buy a target date fund that automatically invests your money into a mix of different assets based on your timeline for when you plan to take the money out.
Are you thinking of early retirement? If you have $3.125 million in inherited funds after paying off your debt and follow the 4% rule, this would produce at least $125,000 in annual income for you.
With that income, you could potentially retire, but keep in mind the 4% rule only works to make a retirement portfolio last 30 years so your safe withdrawal rate will be lower. You might also consider keeping some of the money for future generations. Talk to a financial advisor to figure out when it might be safe for you to give up working.
This simple guide can save you a lot of fees and hassle, allow you to enjoy your life with extra cash over time and help you preserve a large sum for your own future and for future generations. For more personalized advice and a detailed plan, consider talking with a financial advisor.
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[1]. Northwestern Mutual. “As $90 Trillion “Great Wealth Transfer” Approaches, Just 1 in 4 Americans Expect to Leave an Inheritance”
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
