Using an Inheritance or Windfall for Retirement Planning

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Current Gen Xers and millennials stand to be the beneficiaries of a huge transfer of wealth as their baby boomer parents age and pass away. Some estimates put this coming transfer of wealth at $30 trillion.

Financial windfalls can come in many other forms, such as winning the lottery (unfortunately rare), a settlement in a personal injury case, being the beneficiary of a life insurance policy, gambling winnings, a retirement lump-sum or any number of other sources.

What if you were the recipient of an inheritance or some other type of windfall? What should you do with the money? How can you best use this money to ensure a comfortable retirement?

How Much?

The impact any inheritance or windfall will have on your finances starts with the amount. A windfall of $50,000 is certainly nice, but one of $5 million will have a much more profound impact on your life. Don’t make any financial commitments until you know all the details.

What Is the Nature of the Windfall?

An inheritance or windfall can take many forms. Cash is always great and very versatile in how it can be used. You can invest it for retirement or other long-term goals. You can use it to buy virtually anything, pay down debt or any number of other things.

This could include financial assets such as stocks, mutual funds, ETFs or other marketable securities. These can be readily traded as needed.

Retirement assets such as an IRA or 401(k) can usually be converted to an inherited IRA and can be stretched, especially if you are younger than the account holder from whom you are inheriting the assets.

A large lump sum from a pension should usually be rolled to an IRA account as well, to keep the tax-deferred nature of the account intact.

If you receive physical assets such as real estate, art or collectibles, these assets will be less liquid and will often require an appraisal. With real estate, there is usually upkeep involved, including property taxes.

Are There Any Restrictions?

Does the inheritance or windfall come with any restrictions? For example, if you receive shares in a privately held company, there may be restrictions as to whom the shares can be sold to and when they can be sold. There might be certain windows of opportunity during the year or similar restrictions.

An inheritance could come with weird restrictions, such as requiring that you graduate from college, marry by a certain age or never sell the shares of XYZ company. It is important you understand any stipulations of this type.

Don’t Forget Taxes

Your windfall can come with tax consequences. Inheritance and gift taxes allow each person to pass on $5.45 million before federal inheritance taxes kick in. State inheritance taxes vary by state; you will want to know the dollar limits and rates if you are the recipient of an inheritance.

Winning the lottery will, of course, involve a significant tax liability, and so will gambling winnings. Assets such as annuities and retirement accounts will be subject to taxes when the money is withdrawn. Stocks and other investments can be subject to a step-up in cost basis when inherited, mitigating the capital gains hit when sold.

Come Up With a Plan

One of the best things to do upfront is to assess your situation and your financial goals. Don’t feel pressured to make investments or do anything with the money right away. If possible, don’t tell anyone about your newfound wealth. Family and friends have a funny habit of showing up out of the blue expecting a handout.

If you need professional help coming up with a plan, this is a good time to find a fee-only financial advisor who will act as a fiduciary in working with you.

A plan starts with looking at where you are financially and at your financial goals and your priorities. Where do you stand in terms of saving for retirement? Are you hoping to be able to fund all or most of your children’s college education? Are there some things you want to buy, such as a new house or taking that dream vacation of a lifetime?

Any of these and other goals may now be in reach. The key is planning and then implementing your plan.

Using the Windfall for Retirement

There is a number of ways to use an inheritance or a windfall to help fund your retirement.

Inherited IRAs can be a great retirement savings vehicle. If you inherit an IRA account from a parent or grandparent for example, as a younger beneficiary, you can take required minimum distributions based on your life expectancy instead of theirs.

If the account holder had already begun taking required minimum distributions (RMDs), you will need to continue this, but again, based on your life expectancy, allowing you to take smaller distributions and prolonging the tax-deferred growth of the account. If they hadn’t begun taking their RMD, then you can wait until you turn age 70½.

Cash and other taxable assets can help in a number of ways. Investments can be held and allowed to grow for retirement, or they can be sold and the proceeds used to buy more appropriate holdings. Cash can also be used to help you fully fund your 401(k) and an IRA each year. The cash can help replace the money used to make these contributions, allowing for increased retirement savings.

Asset sales can help fund your retirement now or down the road. Whether real estate or artwork, if these assets have the value they can be sold now or later with the proceeds used to help fund your retirement.

Income-generating assets such as rental real estate or an interest-bearing account can throw off cash that could be used to save and invest for retirement.

Further Reading: Best Retirement Tools

Summary

An inheritance or financial windfall can be a life-changing event. If invested wisely, it can fund all or some of your retirement and help you achieve other financial goals. For those who are behind on their retirement savings, this windfall can be a once-in-a-lifetime do-over. Don’t blow it; put the money to good use. Retirement should be a top priority, as you don’t get a second chance there.

Roger Wohlner

Roger Wohlner is an experienced financial advisor, finance blogger and freelance writer based in Arlington Heights, Ill. His expertise includes providing financial planning and investment advice to individual clients, 401(k) plan sponsors, foundations and endowments. Roger contributes to his own popular finance blog, The Chicago Financial Planner, where he writes about issues concerning financial planning, investments and retirement plans. His work has been featured on Investopedia, Go Banking Rates, US News & World Report, Yahoo! Finance, Equifax Finance Blog and other publications. You can follow Roger on: Twitter - LinkedIn

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