In Your 20s With a Large Inheritance? How to Manage Your Extra Money
If you receive a large inheritance in your 20s, it's easy for this windfall to be used unwisely.
The likelihood that you’ve inherited millions and millions of dollars is slim, so don’t spend like you have.
Enjoy a nice meal and night out, then return to your desk on Monday and deposit your money into an FDIC-insured bank account.
With professional guidance, take however much time you need to figure out your goals.
Follow this guide to help manage your inheritance to make the best decisions for your future.
1. Build an Emergency Fund
An emergency fund prepares you for life’s unexpected events, such as the loss of a job or high medical bills.
Fortunately, if you’ve received a large inheritance, you’ll be able to deposit a lump sum of money into an account as a safety net in case of emergency.
How much should you have?
Financial experts advise having at minimum 3 to 6 months of living expenses in an emergency fund.
To calculate how much money to deposit into an emergency fund, start by tallying the amount you spend each month on necessary expenses, such as:
- Housing expenses
- Personal expenses
Depending on the amount of money you inherit, you might want to save up to 12 months of living expenses, or even more.
Where should you keep the money?
Once you decide how much money to keep in an emergency fund, you’ll need to determine where to keep this money.
Your emergency fund should be easily accessible, in case you need to withdrawal it at a moment’s notice.
Ready to open an emergency fund? Consider opening one of these types of accounts:
- Online savings account — A safe and secure way to keep your money, and you’ll even earn a little interest. Online banks typically offer higher interest rates with lower fees compared to traditional banks with brick-and-mortar branches
- Index funds — Although you can quickly access your money, index funds are ideal for long-term investment. By investing in an index fund, you’ll most likely earn a higher return on your money, compared to a savings or checking account.
If you have a major life event, such as getting married or have a baby, you most likely will need to adjust the amount of money you have saved.
Why it’s important: Being prepared for the unexpected keeps an emergency from ruining your financial future.
2.Pay Off Debt
From student loans to a high credit card balance, to a monthly car payment, debt disguises itself many different ways.
Paying down debt in your 20s gives you a fresh start, and you’ll save money in the process.
If you inherited a large amount of money, pay off all your debt.
If you’re not in a position to pay it all off, pay off the loans with the highest interest rates.
For example, if you carry a $10,000 credit card balance at 18.99% APR, and a car loan for $10,000 at 4% APR, pay all or as much of the credit card balance as you can.
It’s important to remember that using one or several credit cards isn’t a bad thing.
Problems arise when you spend more money than you have.
Whether you charge $25 or $2,500 a month on your credit card, be sure you can pay the balance in full and on time in order to avoid late fees and interest charges.
Why it’s important: By paying down your debt, you’re essentially investing in yourself, by not having to pay as much interest.
3. Get a Head Start on Retirement Savings
Retirement might be 30 to 40 years away, but the earlier you save for retirement, the longer your money will be able to grow.
Now you’re able to start an emergency fund and pay off debt, it’s time to look at your retirement plan.
If your employer offers a 401(k) plan, ideally, you’re contributing the maximum amount each year.
If that is not an option, contribute the minimum amount that your employer matches.
An employer matched 401(k) contribution programs basically gives you free money.
This works by preselecting a specified percentage of your pre-tax earnings to be deposited into your 401(k) account each paycheck.
Your employer will then “match” that same amount of money, up to a certain percentage, and that money will be automatically deposited into your retirement account simultaneously.
So, if you opt out of contributing to your 401(k), you won’t get this extra money.
If you do not have a job that offers a 401k plan, financial institutions offer individual retirement accounts (IRAs).
With IRAs, you also need to earn income to contribute, but the limits are lower.
Generally, they work similar to 401(k)s when it comes to focusing on tax-advantaged retirement savings.
Why it’s important: It’s never too early to start saving for retirement.
Establishing good financial habits at a young age will set you up for financial success in the future.
4. Set Up Investments
In addition to an emergency fund, you’ll want to look into investments so your money continues to earn interest and grow.
Depending on the amount of money you inherit, you might want to talk to a financial advisor.
It’s important to set short-term and long-term goals.
Do you want to buy a house? Put away money for your children’s college fund? Retire at 50 years old?
Whatever you decide, take the time to come up with a plan to help achieve your goals.
Why it’s important: You can make money two ways. 1. Go to a job every day. 2. Make your money work for you.
By making smart investment decisions, you’ll be able to reach your financial goals even sooner, and with more money in your account.
5. Spend Some
No matter the amount of money or time that has passed, dealing with grief and loss is difficult for anyone.
Once you take a deep breath and come up with a financial plan, it is okay to enjoy yourself a little.
Whether you want to take a vacation, splurge on a one-time material item, or sign up for a photography class, you can use a small portion of your inheritance on yourself.
Why it’s important: Through the gift of inheritance, the loved one who passed specifically chose you to inherit their hard-earned money.
This is a gift that many are not fortunate enough to receive, so enjoy it a little.
Do You Have to Worry About Taxes?
In general, most people do not have to report an inheritance or pay taxes on the money, property or investments that are passed down to them.
However, there is a federal estate tax imposed on anyone that inherits over $11.2 million.
Since that amount is so high and most people do not inherent that amount of money, the “death tax” does not apply to them.
Additionally, six states impose an inheritance tax: Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey and Maryland.
Once the money is in your account, your taxable income changes.
Treated as ordinary income, you will have to pay tax on any interest or earnings paid from the day the inheritance was deposited into any of your accounts.
Essentially, once that money is in your possession, any additional money you earn is treated as normal income and taxed accordingly.
Tax law is complex and ever-changing, so it’s best to seek out the guidance of a CPA or tax attorney to assure you are in compliance with all state and federal laws.
You don’t want the IRS to come knocking on your doorstep.
4 Tips for Better Money Management
It’s not uncommon to hear how lottery winners squandered away their millions.
Don’t make those same mistakes.
Even if you didn’t inherit millions, consider these guidelines to keep you on track:
- Don’t spend crazy — Any amount of money that you receive unexpectedly can seem like a large amount of money, especially in your 20s. Don’t run out to buy that Porsche or quit your job.
- Keep it to yourself — If you inherited a large amount of money, keep that information to yourself and your spouse or parents. Long lost relatives and friends can come out of the woodwork asking for handouts.
- Hire a team of professionals — Hire a team of financial professionals to help manage your fortune. Consider hiring a financial advisor, CPA and possibly even a tax attorney, if you inherited over $11.2 million.
- Keep your job — At such a young age, even if you come into a great amount of wealth, keep your job. You’re 30 to 45 years from retirement and a lot can happen before then. If you inherited a large amount of money and hate your job, you now have the flexibility to pursue a different career that may speak to your heart, rather than your bank account.
With your whole life ahead of you, make the most of your inheritance by making smart financial decisions.
You’ll never regret setting yourself up for a secure financial future.