Getting an inheritance can be a nice bonus in life and many Canadians – boomers and Gen X are first in line – are expected to get a chunk of change as part of what's being called the largest intergenerational wealth transfer in history. Over $723-billion of Canadian assets are set to change hands over the next ten years according to a 2017 report from Strategic Insight. But while the thought of 'free money' may have many laughing, not everyone will laugh all the way to the bank.
Studies show that one-in-three Americans burn through their inheritance within two years because of financial mismanagement. Often, a lack of financial literacy and not enough communication and guidance between benefactors and their heirs is at fault. But there's also a psychology to unexpected windfalls and inheritances – a sense of 'found' money – that leads many people to spend it more easily than hard-earned income.
Even the more prudent among us can find it overwhelming trying to decide on the best course of action. Should you save it for retirement, put it towards your mortgage, pay off student debt, or donate some to charity? And while everyone would like to splurge on something for themselves, how much should you spend?
The answer is usually a combination based on your individual circumstances and the amount of the inheritance. Regardless of whether it's a lot or a little, if you're about to come into money, here's how to make sure you hold on to it.
Get professional advice.
Everyone understands money, but few really understand finances. It can be a complicated – and even emotional – topic so the first step is to speak with your accountant or a financial advisor that knows about taxation and can help evaluate your situation. One of your biggest expenses in life won't be your mortgage, it will be the taxes you pay, so you'll want to minimize or defer those wherever you can. For example, my mother's estate included several accounts, and I learned that some should be cashed out before others to avoid being taxed right away.
In addition to expertise and planning, advisors will usually act as a sounding board and 'conscience' for your spending. If you don't already have an advisor, ask for referrals from family or trusted friends to make sure you work with someone who has a good track record.
Prioritize your future.
Once you've reviewed your financial position, you'll have a clearer idea as to where and how to allocate your money. In their excitement many people will go on a spending spree but common sense is to get rid of or reduce debt first, especially high-interest debts such as credit cards and unsecured lines of credit. This will help ease up cash flow so you can direct money towards your mortgage or other investments such as RRSPs, RESPs or TFSAs. Even a modest inheritance that's invested properly now can grow sizeably by the time you retire.
I was 35 when my father passed away, and I used my inheritance as a down-payment on my home, while my sister used hers to pay down her mortgage. For others, it may make sense to put more towards retirement or additional investments. If you don't already have it, consider buying or topping up life insurance and disability coverage to safeguard your wealth should something happen to your health.
Consider your own legacy.
As people age, their financial priorities are usually preserving wealth and minimizing risk to make sure they have enough money to live comfortably in retirement, and leave something behind for the next generation. Whether you have children or not, how will you create your own legacy? Some people donate their wealth to a favourite charity or cause, an educational institution or to support their community. Make sure you have all your affairs in order with a proper will and estate plan to limit the burden – and cost – on executors. I agreed to be an executor for my neighbour but had no idea how difficult and time-consuming the process would be.
Investment vehicles such as segregated funds allow you to grow your money while guaranteeing a portion to mitigate risk. They also provide estate planning and tax benefits including the ability to bypass probate, and an immediate payout, saving loved ones time and additional costs.
Of course, you'll want to set a little bit aside to treat yourself, and that's okay. Everyone's needs will be different depending on their situation and stage of life. While there's not one answer, following these basic tips will help make sure you don't end up squandering the gift of an inheritance.