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What Tax and Investment Issues Should I Consider for a Large Inheritance?

By Carolyn Curci

The largest transfer of wealth in the history of America is now taking place, as baby boomers begin to receive their inheritances. Its total is in the trillions of dollars. Many of the heirs have been raised in families with considerable wealth, and many more will be introduced to personal wealth for the first time. There is no guarantee that either group will be successful in managing their new money. The simple fact is that, unless someone tells you how to prepare yourself to receive a large sum of money, you can't be ready to make the most of it.

     The four steps to managing this wealth transfer successfully are: (1) creating a plan, (2) finding an adviser, (3) allocating your assets, and  (4) planning your estate, or the eventual transfer of the wealth you will accumulate through the smart management or your inheritance, to your own heirs.

     Creating a Plan: First, it helps to know what you want this money to do for you. To identify your goals, write down an informal or formal list of the things that you'd like to do with the money you are about to inherit, breaking them down into short-term, mid-term and long-term goals.  Typical short-term goals might be buying a new car, making a down payment on a home, enrolling in college courses to further your education, or establishing a business. Potential investment choices to achieve those goals might include Treasury bills, certificates of deposits, money-markets funds, and short-term bonds.

     Next, identify the major expenses you visualize over the next 10 years—such things as education for your children, purchase of a larger home or a second home, and travel. These will become your mid-term goals. Potential investment vehicles to secure these goals might include high-rated bonds or bond funds, stock in well-established companies, stock mutual funds, Treasury notes, and zero-coupon bonds. Your long-term goals are your retirement goals.

     Common retirement goals are having enough money to travel and to pursue hobbies; maintaining the life style you’ve grown accustomed to; being able to afford long-term health care, should you or your loved ones need it; helping your children and passing on an inheritance to your heirs. The best way to achieve these goals is to commit a percentage of your income to tax-deferred investments and let them grow. Potential choices are growth stocks, stock mutual funds, high-interest bonds, long-term bonds and zero-coupon bonds

     Finding an Adviser: Expert advice is the key to making strong financial decisions. The difference between getting advice and doing without it is often the difference between moving forward toward your goals and being stuck where you are. Types of advisers to consider are Bank Investment Representatives, Stock Brokers/Financial Consultants, Certified Public Accountants, Financial Planners and Insurance Agents. [Look for professionals who charge a flat hourly fee as opposed to those who work on commission, to ensure that their recommendations won’t be influenced by the possibility of personal gain.]
 

     Allocating Your Assets: Stocks, bonds and mutual funds are the substance of a diversified portfolio—and with good reason. These investments are easy to buy and sell, provide a wide range of choices and have the potential to provide the primary benefit of investing—added financial security.                                                         

     Other investments include certificates of deposits; real estate, which may increase in value and can provide tax advantages; and annuities, which are tax-deferred investments designed to provide future income at either a fixed or variable rate. Depending on the amount of money you have to invest and your risk tolerance, you might also consider art and collectibles; gold and other precious meals; and speculative investments, such as futures and options, which change in value as the investments they're derived from change in price.

     Tax-Wise Investing: Inflation nibbles away at your investment earnings over the years, but taxes can take big bites every year. So be tax smart. Do tax-preferred investing first.  The solution isn't to avoid investing. Instead, include some tax-saving strategies in your overall financial plan. Different types of tax savings can be found in tax-free municipal bonds, tax-deferred IRA's, 401(k)'s and annuities. The Congressional Budget Office calculates that if you earn 8 percent for 15 years in a tax-deferred retirement-plan account, you'll have 37 percent more after taxes (if you’re in the 28 percent tax bracket) than you would if you'd been paying taxes all along.

      You can invest money that you've earmarked for your long-term goals through a tax-deferred retirement account and postpone paying taxes on your earnings. This can be a plan your employer provides, one you set up yourself, or a deferred annuity or certain kinds of life insurance. Another way to avoid paying current taxes is to put your money into growth investments that pay little or nothing now but may be very valuable later. Of course, you have to accept the risk that your investment might decline rather than grow in value.

     Remember, investing, like a healthy diet, requires diversity and balance. Decide how much to allocate to growth and how much to income investments. Then divide both growth and income investments into three parts, putting the bulk of the money you invest in each type into moderate-risk investments, some into low-risk investments, and the least amount into high-risk investments. Creating a diverse portfolio means putting money into a variety of investments, following a well thought-out plan. An aggressive approach would be 80 percent stocks, 15 percent bonds, and 5 percent cash. A moderate approach would be 60 percent stocks, 30 percent bonds, and 10 percent cash. A conservative approach is 40 percent stocks, 40 percent bonds, and 20 percent cash.          

     Planning Your Estate: When you're making your investment decisions, choose the route that's best for you, and realize that your financial goals will probably shift overtime, as your circumstances and priorities change. Setting up a timetable doesn't mean that you're locked into anything. In fact, you should plan to revise your approach regularly—probably once a year. Finally, consult the financial adviser of your choice about the best ways (trusts, charitable foundations, etc.) to transfer the wealth you accumulate to your heirs or the charitable beneficiaries of your choice.

     As you can see, a wealth of choices comes with any inheritance.

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Carolyn Curci is a Vice President and Financial Adviser with

Janney Montgomery Scott.You may contact her at ccurci@jmsnonline.com.

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