When you receive an inheritance, you may be wondering what to do next. No matter if it's a modest or substantial amount, handling it responsibly is one way you can honor the family member who left it to you. Here are some ways to help you decide what to do.
Your Budget: Shore up the Weak Spots
Are there some financial habits you'd like to improve? If you want to get on track, here are some rules of thumb regarding how to spend and save. Keep in mind that in some high-cost areas like California, your housing costs may likely range between 36% and 40%.
If you discover that you are generally spending more than your budget allows and not saving enough, use some of your inheritance to improve your financial situation including:
- Paying off High-Interest Credit Card Debt
Getting rid of high-interest debt is one of the quickest ways to improve your finances and free up cash to save more.
- Establish an Emergency Fund
Having a healthy emergency fund will keep you from racking up debt again if something unexpected happens. Use some of your inheritance money to start your rainy day savings, and keep adding to it by setting up automatic payroll transfers to a designated savings account, preferably one not connected to your checking account, to avoid spending it on everyday needs. Your first goal should be to save at least $1,000, with an end goal of saving up to six months of your salary.
- Build Your Retirement Savings
Once you've attacked high-interest debt and established or added to your emergency fund, address your retirement savings. If you have access to a retirement plan such as a 401(k), 403(b), or 457(b), make sure you're taking full advantage of it because in most cases, employers will match retirement contributions — typically from 2% to 8%. Contribute at least the max of the match, otherwise, you're just walking away from free money. And work to boost your contribution amount, especially when your income increases. The 2023 contribution amount to a 401(k) plan is $22,500, if you're under 50, and if you're 50 and over, you can contribute an extra $7,500. Your contributions are deducted automatically from each paycheck and use pre-tax dollars, so you'll only pay taxes on that money as you start withdrawing it in retirement. If you don't have an employer-sponsored plan, consider opening a Traditional or Roth IRA.
- Start a College Savings Plan
If you have children, you may be thinking about ways to help them pay for college when the time comes. By starting early, and contributing regularly to a plan, you can help them get a jumpstart on college tuition. But make sure you have your retirement savings on track because while there are loans, grants and scholarships to help pay for college; there are no loans for retirement.
- Splurge a Little
While it's important to address certain financial goals, you'll want to spend some money on yourself and your family. Just limit your fun spending to around 5% to 10% of your inheritance.
This article is for informational purposes only. Please consult a qualified tax professional for tax advice on your specific situation.