If you’ve received an inheritance, or are preparing to receive one, do you have a plan to maximize the money? Of course, maximization depends on your financial situation. We find that people are in one of three stages of wealth building.* What you do with your windfall depends on your current stage.
*Grant outlined the Three Stages of Wealth Building in Stewardship’s YouTube channel. Click here to check out the Wealth Building playlist.
What to do with $100,000 in each stage of wealth building
Stage 1: Pay off debt and save.
The first stage of wealth building is characterized by trying to gain control of your finances. You might be trying to control your budget, your debt, or trying not to spend more than you bring in. How can you use a windfall to help you gain control?
If you have debt that is sucking cashflow from your budget, paying this off can take you to Stage 2 rather quickly. But what if you have more debt than money from your inheritance?
Instead of splitting it pro rata to all your debts, I would try to pay off as many smaller loans as possible. Then, take what you were paying to those loans and apply it towards your remaining loans. This snowball effect will allow you to pay off the remaining debt quicker. Plus, it gives you small victories along the way.
- Stock your emergency fund.
To equip yourself for emergencies, aim for six months of expenses that can be put away in a bank or investment account.
By paying off debt and financing your emergency fund, you should now have enough cash flow freed up to feel more in control with your finances. Now you can start thinking about the best place to put your newly found cash flow as you enter Stage 2.
Stage 2: Fast-track your wealth building.
The second stage of wealth building is making the most of your margin. You make more income than you spend, you’re prepared for unexpected expenses, and you have started investing.
So, what should you do with $100,000?
- Start a non-qualified investment account
Also known as a “taxable” investment account, this just means it does not have special tax benefits like an IRA. This also means it has more flexibility. You can put all $100,000 in there at once, and make withdrawals anytime.
A company 401(k) is great, but I find that people who are truly on the path to wealth building are looking outside of their retirement accounts to maximize their margin. Getting familiar with investing outside of just your 401(k) is where we find most people in Stage 2. An inheritance can accelerate this journey.
- Use the money to pay taxes on Roth conversions.
Roth IRA’s mean your future retirement will be tax free. Many used pre-tax 401(k)’s and Traditional IRA’s in the past. Did you know that you can convert your pre-tax IRA to a tax-free Roth IRA?
Doing this is called a Roth conversion. It doesn’t count towards your annual Roth contribution limit, so you can convert as much or as little as you want. You can even convert over several years. The problem is, any amount you convert is counted as taxable income in the year of conversion.
While this sounds like a bummer, it can be beneficial. Because your retirement dollars will likely grow and compound over many years, you end up paying tax on a relatively small amount today in exchange for a much larger amount in the future that will be tax-free.
Since you will incur a tax bill, you can use part of your inheritance to pay for the income taxes.
- Fund a college savings account.
Future college expenses are tough to save for. College is expensive, you have a short time to save, and as a result, compounding growth doesn’t benefit you as much. An inheritance can be used to fund 529 College Savings Plans for your kids.
You can open a 529 Plan for each child and fund as much as you’d like. You don’t have to worry about contribution limits and future withdrawals for qualified education expenses are tax-free.
Stage 3: Maximize your money.
The third and final stage of wealth building is characterized by one word: impact. At this stage, you can make a big impact with your money because of the intentional steps you’ve taken to get here.
Not only do you have the correct habit of saving and investing, but your net worth is likely six or seven figures.
What should someone in the third stage do with $100,000?
- Maximize any under-funded goals.
Since you’ve been in stage 2, you probably have a non-qualified investment account and maybe even college savings already set up. Which of these goals needs further attention?
- Fund your long-term care plan.
If you’re 50 years or older, consider using your $100,000 to map out your long-term care plan. While most wouldn’t need extended care until later in life, it’s crucial to plan now. Why? Lengthy custodial care later in life can drain your assets and put stress on your spouse and kids.
Start with the assumption that you’ll need some type of care, even if it’s in your home. With this in mind, consider your options for funding this care. The benefit of insurance is that it leverages your dollars to provide a much larger benefit for future care.
My encouragement is to seek the advice of a financial planner. People in stage three have financial lives that are more nuanced than the other stages. Simply put, you have more at stake.
For example, Roth conversions can be great, but you also could be in a higher tax bracket. Doing Roth conversions in some brackets can trigger unintended costs. How much should you convert? Are there additional taxes owed that you aren’t thinking of? It’s crucial that you make the correct decisions at this stage, as the wrong (or sub-optimal) choices can have greater consequences.
Lastly, financial advice that you find in the media isn’t necessarily for someone in your stage. The advice given to the masses might not apply to someone with your wealth, income, or goals.
Talk with our advisors
Hopefully grandma is alive and well! But if you are struggling to find the correct advice for your situation, the investment advisors at Stewardship are here to help.
Click here to request an appointment with one of our investment advisers.