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Financial windfalls are a dangerous blessing. A settlement, lottery winnings or an inheritance are just a few ways you can find yourself suddenly wealthier than you were the day before. But many have found that losing wealth can come almost as quickly as gaining it.
Millions of Americans could face this issue over the next few decades as a result of the Great Wealth Transfer. According to SmartAsset, Americans over the age of 55 currently control nearly 75% of the country’s wealth, and Baby Boomers alone carry more than 50% of it.
That wealth — estimated to be between $84 trillion (about $260,000 per person) and $124 trillion (about $380,000 per person) — will transfer primarily to Gen X and Millennials over the next 20 to 30 years. Women are expected to control a substantial portion of this wealth due to their longer life expectancies.
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So how can you make the most of inherited wealth? Here are four mistakes to avoid if you find yourself participating in the Great Wealth Transfer.
1. Making quick decisions
Waking up wealthier than you were yesterday can cause numerous temptations. It can be hard to resist living a more lavish lifestyle when your circumstances change. But without a proper plan in place, spending can get out of control fast.
The true number is hard to determine, but the American Bankruptcy Institute reports that a large proportion of lottery winners wind up bankrupt.
You may quickly regret that big purchase. You may overestimate your inheritance when you pay off that debt, finding yourself cash-poor. You may entrust the wrong party with the complicated inheritance process.
If you find yourself thrust into this world, react cautiously. Take a measured approach to each decision, and ensure you’ve fully thought through your steps before you take them.
2. Pressure from loved ones
With lottery winnings, some states allow anonymity when claiming your prize, while others do not. In any case of financial inheritance, word travels fast.
It’s common for family or friends to come calling for financial favors. Some may offer potential investing opportunities and make use of your previous connection.
Saying “no” to loved ones is never easy, but saying “yes” to everyone will almost certainly guarantee a quick depreciation of your newfound assets.
It is highly recommended that you employ a financial professional to help manage your new wealth. Your financial adviser‘s role is to grow your wealth, not take a slice of the pie. They will help you manage not only your finances, but also the difficult decisions you will no doubt need to make.
3. Ignoring tax implications
Receiving your inheritance can trigger estate, capital gains or income taxes depending on your state and situation. Don’t rush to liquidate your assets. Withdrawals from inherited IRAs or 401(k)s are taxed as ordinary income because they were funded pre-tax.
Additionally, many of the assets you inherit can be updated in cost basis according to fair market value at the time of the original owner’s passing. As the beneficiary, you can use this adjustment to minimize the impact of capital gains taxes.
Once again, unless you’re a tax professional yourself, strongly consider hiring a financial adviser, CPA or estate attorney. Trying to navigate these intricacies alone could lead to major losses.
4. Failing to create new long-term goals
This is the greatest mistake an inheritor can make. If your financial situation changes, so should your long-term financial goals.
How much were you saving for retirement previously? What investment strategies are now available to you? What do your dreams look like in your new circumstances? What may have seemed unreachable before could become a reality, but only if you adjust your plan and create a new, realistic timeline.
It’s reported that 70% of inherited wealth is depleted in the second generation. According to AMG National Trust, by the third generation, that metric reaches 90%, and generational wealth has suddenly evaporated.
An inheritance is a blessing and gift that exists because someone else thought of you and took the time and energy to build a plan for your future. Honoring that work is a tremendous way to thank them for their thoughtfulness and love.
The most important action you can take is to remain mindful of your decisions and approach them in a way that honors not just the gift, but the giver.