Overview of Medicare Enrollment
One important area of planning for a successful retirement is to have adequate health care coverage. Health care costs have been escalating at over twice the rate of inflation for a number of years. For those wanting to retire prior to age 65, health care is typically one of the largest “bridge” expenses to cover until Medicare eligibility.
For most people, their health insurance is provided through their employer. Or, if self-employed, they likely own a private health insurance policy. But once you reach age 65, you have the opportunity to transition to the federal government’s Medicare health care system. This article will provide a quick overview of some of the options available, answer some frequently asked questions and provide some resources to help you navigate the system.
Medicare consists of four main parts:
Part A – is hospital insurance and provides coverage for inpatient hospital services, care received in skilled nursing facilities, hospice care and some home health care. There is no premium cost for this coverage. However, there are co-pays, deductibles and co-insurance when seeking medical care.
Part B – is medical insurance and provides coverage for outpatient care such as doctors’ visits, laboratory and imaging tests, medical supplies and preventative services. There is a monthly premium which is automatically deducted from your monthly Social Security check. If you are not receiving Social Security benefits, your premium will be billed to you once a quarter. In 2016 the base premium is $121.80/month. You may pay a larger premium if your annual income is higher. You can learn more about your potential premium costs by reading the article I wrote titled “How Much Will I Pay For Medicare Premiums?” Your Part B coverage generally covers 80% of your covered care expenses after a deductible has been met.
Part C – is Medicare Advantage Plans, which are Medicare approved private insurer plans that typically provide medical coverage for Part A, Part B and often include prescription drug coverage. Many of these plans provide extra coverage and may lower out of pocket costs.
Part D – is prescription drug coverage. This particular coverage is optional and has a monthly premium that varies depending on the plan you choose. Similar to Part B coverage, those with higher levels of income may pay higher premiums. The link to my article above provides a chart of premium surcharges for Parts B and D based on income level.
What is Medigap insurance?
In addition to the options mentioned above, there are approximately 12 different private insurance plans which vary by state. These extra coverage plans are often referred to as Medicare supplemental insurance or Medigap. These policies are designed to fill in the coverage gaps found in Original Medicare Parts A and B. A large percentage of those receiving Medicare are also enrolled in one of these policies.
When to apply
If you are already receiving Social Security benefits prior to turning age 65, you will automatically be enrolled in Medicare Parts A and B. If you are not receiving Social Security benefits, then you have a seven month window to apply. You can apply 3 months prior to turning age 65, the month you turn 65, and up to 3 months after you turn 65. Your Medicare benefits will generally begin approximately one month after you enroll.
How to apply
You can enroll in Medicare Part A and Part B in the following ways:
• Online at www.SocialSecurity.gov.
• By calling Social Security at 1-800-772-1212, Mon to Fri from 7am to 7pm.
• In person at your local Social Security office. It is recommended that you call first for an appointment.
How do I determine if I should choose a coverage plan for Part C, Part D or a Medigap policy?
Because each person has a unique healthy history with specific health coverage needs, you may want to consult with a local resource to help you compare and contrast your options. Every state offers a free health benefits counseling service for Medicare beneficiaries. You can click on this link and search by your state for the local SHIP office (State Health Insurance Assistance Program). This is a valuable service available to answer all of your Medicare questions. You can also seek a private, independent health insurance broker that specializes in Medicare plans.
What if I don’t enroll on time? Is there a penalty?
If you don’t sign up for Medicare Part B (medical insurance) when you are first eligible at age 65, there is a 10% penalty for every 12 months you are not enrolled on time. The current base premium for part B is $121.80. Thus you would pay an extra 10% every month for this premium going forward. If you didn’t sign up for 2 years you would pay 20% extra every month for as long as you are enrolled in Part B.
What if I didn’t enroll in Medicare because I had health coverage provided by an employer?
Medicare does provide an exception if you are covered under group health care via an employer. You need to provide a “letter of credible coverage” from your employer when you sign up and they will usually waive the penalty.
Additional resources for your Medicare questions.
Besides the SHIP link above, or an independent health insurance broker, another option is to call Medicare directly at 1-800-Medicare or 1-800-633-4227. If you prefer searching for your answer online, you can go directly to www.Medicare.gov.
IRA Required Minimum Distributions (RMDs)
The IRS incentivizes investors to make tax deductible contributions to a number of different tax-deferred accounts such as an IRA, 401(k), SEP IRA, SIMPLE IRA or 403(b). For many investors this is their primary way of saving for retirement. The IRS allows the tax deduction on initial contribution and the continuous tax-free compounding of growth until distributions are taken or required. Any withdrawals in retirement are taxed as ordinary income for federal and state taxes if applicable. If you initiate a withdrawal prior to age 59 ½, not only will you pay taxes on the distribution, but you will also have to a pay a 10% early withdrawal penalty.
When do I have to start Required Minimum Distributions (RMDs)?
Once you reach age 70 ½, the IRS requires that you begin taking a mandatory distribution on a yearly basis from your tax deferred account. You didn’t think the IRS would let you keep deferring taxes forever did you? If it’s the first year of distribution, you can take the withdrawal by April 1st of the following year after you turn 70 ½, but you would have to take two distributions in this second year. Most investors take the distribution in the initial year so they do not have as large of a taxable distribution by waiting until the second year to start taking RMDs.
How do I determine the amount of my RMD?
The IRS has a life expectancy table which I have reproduced below. (Note, this is one of three types of life expectancy tables. The other two tables relate to inherited IRAs and if you have a spouse more than 10 years younger than you. For illustration purposes, the table below will apply to most investor’s financial situations. However, you should consult your CPA and fee-only financial planner to help you with the RMD calculation). The amount of your RMD is based on dividing your previous year’s 12/31 account balance by the “Divisor” in the table related to your age. For example, let’s assume you are turning 70 ½ in 2016. You would take your IRA or other tax-deferred account balance as of 12/31 of the prior year, 2015 in this case. Let’s assume it was $100,000. You then divide this by the “Divisor” factor of 27.4, which equals an RMD of $3,649.64.
|Age||Divisor||% Withdrawal||Age||Divisor||% Withdrawal|
Source: IRS Publication 590
For fun I added a third column which converts the “Divisor” into a “% Withdrawal” to better show the impact of the RMD increasing over time. At age 70 ½, the “Divisor” requires a relatively small distribution, equivalent to approximately 3.6% of the tax deferred account balance. But as you see above, the “Divisor” goes up each year of age thereby increasing the withdrawal rate as a percentage each successive year. By age 80, the “Divisor” is 18.7, equating to a withdrawal rate of 5.3%, and at age 90, the “Divisor” is 11.4, equating to a withdrawal rate of 8.8%. The withdrawal rate continues to increase with age as the IRS wants to make sure it is receiving tax dollars in exchange for all those years of tax deferral!
Should I take the distribution all at once?
You have options for the withdrawal. It can be taken in a lump sum or over a period of time within the year of each RMD. If the required amount is relatively large, you could pro-rate the distribution and withdraw funds monthly over the course of a year. Since most people pay their bills monthly, this may help to provide a consistent income stream on a month-to-month basis and allows the funds to remain invested in your IRA/tax deferred account and potentially grow for as long as possible.
What if I have more than one IRA or tax deferred account?
Typically each separate account will require an RMD. There are situations where you can take one distribution from one IRA to cover for multiple IRAs and meet the RMD requirement for all of your IRAs. However, you should consult with a fee-only financial advisor and/or your CPA to make sure you are taking the appropriate RMD if you have multiple tax deferred accounts.
What if I forget to take my RMD withdrawal?
The IRS imposes a 50% penalty on any RMDs not taken. This is the stiffest of any IRS penalties. This penalty is in addition to any ordinary income taxes you will owe on the distribution. Most investment custodians do a good job reminding their investors of the annual RMD. However, if you do happen to miss an RMD, you will want to consult your CPA as special forms need to be filled out and submitted to the IRS when catching up on any missed RMDs.
What if my income needs in retirement are greater than the RMD?
You can always withdraw more than what is required by the RMD. A higher withdrawal amount will generate more ordinary income taxes. If you have taxable assets, you may be able to take a portion of withdrawal from this source to complement the RMD as taxable assets are typically taxed at more favorable capital gains rates versus ordinary income tax rates.
Every investor has a unique tax situation. Your comprehensive financial planner can coordinate and recommend the best combination of withdrawal amounts between your tax-deferred and taxable accounts, in addition to coordinating this with your Social Security benefits, pensions, deferred compensation, rental income, or any other sources of income you may have in retirement. Your fee-only certified financial planner can also ensure you are on track for a successful retirement.
Using Your IRA as Part of Your Wealth Transfer LegacyI’d like to thank Michael J. Garry, CFP®, JD/MBA for today’s post about Using Your IRA as Part of Your Wealth Transfer Legacy. Michael is a Certified Financial Planner practitioner (CFP®) and financial advisor in Newtown, PA. His firm, Yardley Wealth Management, LLC, performs comprehensive financial planning and in-house investment management. I highly recommend if you’re in that area you reach out to Michael for further financial tips and help!
One way of extending the life of your wealth through generations is by implementing a stretch IRA strategy. By designating the beneficiaries with the longest life expectancy the IRS will have lower imposed required minimum distributions for the inherited IRA. The asset base that is left is larger which will help it grow more quickly.
Factors to Consider
It is important to take into account important factors before making this type of decision:
- If you need to withdraw more than the RMD amount, review how much the projected remainder of your IRA will be in the future.
- If you are married, and wish to implement this strategy, but list your spouse as the primary beneficiary and then, those in later generations as secondary beneficiaries.
When making the choice to implement this strategy, you name one or more individuals with the longest life expectancy as beneficiaries. Ideally, you would take only the required minimum distributions during your lifetime. This will leave the largest remainder possible to grow tax-deferred while you’re still alive.
Distribution Options for Beneficiaries
Depending on whether your beneficiaries are spousal or non-spousal and whether or not you had begun taking RMDs, beneficiaries will have several options for distribution from their inherited IRA.
They may include:
- Taking a lump sum.
- Transferring the account balance to an inherited IRA with a five-year time limit to start distributions.
- Transferring the account balance to an inherited IRA that will distribute assets according to the beneficiary’s life expectancy.
Spousal beneficiaries have the additional option of requesting a spousal transfer, which allows them to roll over the account balance into an IRA in his or her own name.
The Benefit of a Roth IRA
Roth IRA contributions are not tax-deductible, your investments grow tax-free, earnings can be withdrawn income-tax-free if you’re at least 59½ and have had the Roth at least five years, and there are no RMDs at age 70½.
Spouses essentially are able to treat the Roth IRA as if they were the original owner because they not only do not have to pay taxes on it, but they are not required to take distributions either.
Change is possible
As with any estate-planning technique, your plans may evolve over time. All IRAs give you the flexibility to begin taking penalty-free distributions as early as age 59½. In addition, you can change the beneficiary at any time should your beneficiary’s needs change.
If your ultimate goal is preserving wealth for future generations, a stretch IRA strategy will generally allow you to grow your assets for a longer period of time and allow them to continue to grow after you pass.
401(k) Options When You Leave Your Employer
Regardless if you are retiring or moving to a new employer, once you leave your current job you will need to decide what to do with your 401(k). You have a handful of choices. I have outlined the benefits and disadvantages of each option below. Your personal circumstances may favor one option over the other. I highly recommend you discuss your options with your fee only financial advisor whenever you transition employment so he/she can help you determine which pathway provides the best choice for your unique financial situation.
1) If you have a balance of $5,000 or greater you can likely leave it in your current plan as most 401(k)’s provide a deferral option.
a) This is the easiest decision and likely no action is required on your part. Although, I am always amazed how many investors choose this default option when there are better choices as described below.
a) Every 401(k) plan has its own unique set of investment options. Your current plan may have a limited choice of investment options such as being overly U.S. centric. We live in a global economy and I believe portfolios should provide a decent amount of international options on both the stock and bond side of investment choices.
b) Many 401(k)’s have incredibly high internal expenses. It is not uncommon to see mutual fund choices with expense ratios north of 1.5%. It is very important to keep an eye on your overall investment expense exposure. The more you can lower your investment expenses, the higher probability you can keep returns compounding for your long-term financial benefit.
Be aware that if your balance is less than $5,000, you will want to take action on one of the below choices as your employer may have the option to automatically cash your 401(k) account out or transfer you to an IRA. Cashing your 401(k) account out can have large tax consequences as outlined later in this article.
2) Rollover your balance to your new employer’s 401(k) plan.
a) This is a good way to consolidate financial assets, especially if you have more than one 401(k) from past employment. I always favor consolidation and simplification where possible.
b) This could be a great choice if you have an excellent set of diversified investment options that are low cost.
a) It is not uncommon for your benefits department at work to occasionally choose a new custodian or a new set of investment options in your 401(k) every few years. You have less control in this situation as you are forced to invest in whatever options are provided. What may look great today could easily change unexpectedly.
b) Your new 401(k) may have poor investment choices, and/or investment options with high expenses.
Most 401(k) rollovers are initiated from the 401(k) you are leaving. Your human resources department or benefits office may require that you fill out a termination/rollover packet of paperwork. Some 401(k) custodians may take direction over the phone. Collectively you and your financial planner can determine what is the next step to move forward and he/she can help with completing any necessary paperwork.
3) Rollover your 401(k) to an IRA
a) This is typically my favored option. Once you set up an IRA you have the whole investment universe of options to invest in. This could be mutual funds, ETFs or stocks. It is easy to build a well-diversified portfolio when you have such a wide array of investment options to choose from.
b) You have control over your money. You can always move your IRA to another investment custodian if you prefer a change of investment options.
c) You will have control over investment expenses. There are a number of low cost investment options available via no-load mutual funds and ETFs at a number of investment custodians.
a) If you are still working, you may end up with one extra investment account in a separate IRA. This is a minor disadvantage. The benefits of investment selection and cost control provided with rolling your 401(k) to an IRA easily outweigh the disadvantage.
4) Cash out your 401(k)
a) None, other than liquidity if you are in a situation desperate for cash.
a) This is typically the worst decision you can make as any balance withdrawn is a taxable withdrawal. Your 401(k) custodian is required to withhold 20% in federal taxes, but your tax exposure could be higher depending on your marginal tax bracket.
b) You will owe state income taxes on the withdrawal if you live in a state that taxes income.
c) If you are under age 59 ½ you would also be subject to a 10% early withdrawal penalty.
d) If you have an outstanding 401(k) loan balance, the loan would also become a taxable event and be subject to the taxes and penalties described above.
e) You will miss out on any future tax-deferred compounded growth by cashing out your 401(k) today.
There are a couple of other scenarios to be aware of before deciding on one of the above choices:
1) What if you have a loan balance against your 401(k)?
a. You typically have 60 days to pay back a 401(k) loan after leaving employment. After 60 days, your loan balance will likely be considered a taxable distribution and you will be subject to taxes and possibly a 10% early withdrawal penalty if you are under 59 ½ years old.
2) What if you have greatly appreciated employer stock in your 401(k)?
a. You may have a tax preference option called Net Unrealized Appreciation or NUA which allows you to transfer the stock out of the 401(k) and pay ordinary income taxes on the cost basis and capital gains taxes on the gains. You will want to review this option in detail with your financial advisor and CPA prior to making any decisions.
In closing, I highly recommend you notify your financial advisor of any employment changes which could impact your 401(k) options. Once he/she is aware of your options, they can help you determine what the best course of action is for your personal financial situation. Your financial planner can also join in a conference call with your benefits department and/or 401(k) custodian to make sure you both understand all of your options and what steps are required to move forward.
How Much Will I Pay For Medicare Premiums?
Note – some investors well below age 65 may not read this assuming it does not apply to them or Medicare is too far away. However, I think this is valuable information to understand because the federal government’s shift towards “means testing” will likely grow as a larger portion of the national budget transitions toward entitlement spending for Medicare, Medicaid, Affordable Care and Social Security in the years to come.
Many of those aged 65 or greater with higher incomes are sometimes surprised at the amount they have to pay for Medicare medical insurance (Part B) and their Medicare prescription drug coverage (Part D). Unbeknownst to some, Medicare started means testing in 2007 to determine your Part B premium. In 2011, they also began means testing for Part D.
Means testing is another way of saying they are assessing your annual income and those with higher incomes will pay higher premiums.
Medicare uses a cost sharing formula with the intent that a tax payer will pay approximately 25% of their Medicare premium and the government pays the other 75%. The share cost for those impacted by means testing ends up rising from 25% to 35%, 50%, 65% and potentially 80% if their income meets the highest income threshold, as outlined later in this article.
How do they assess my income?
The income reported is taken directly from your 1040 tax return filed with the IRS. They use a Modified Adjusted Gross Income (MAGI) number, which is essentially your Adjusted Gross Income (AGI), line 37 of your 1040 and add line 8b (any tax-exempt income). Note, these are gross income numbers. Unlike on your tax return, they are not reduced by personal exemptions or deductions.
How often do they review my income?
This is reviewed annually. Typically there is a two-year time lag. For example, I am writing this in 2016, but Medicare likely reviewed your 2014 income (reported on your 2015 tax return to the IRS) to determine your 2016 premiums.
What could impact my income for the purposes of determining my Medicare premium?
There are a number of potential situations or events that could increase or decrease your income from year to year, thus impacting your Medicare premium:
- If you retire near age 65 with high earned income, your initial premiums may be initially higher until the 2 year time lag of tax returns shows a lower income in retirement.
- A large Roth IRA conversion could increase income.
- If you experienced a large amount of capital gains via stock sales or a property sale, you may have a higher MAGI.
- If you sold stock options near, or in, retirement that could drive up your income.
- If you take large IRA distributions in retirement, or beginning at age 70 ½ when IRA distributions are mandatory.
- If you receive large deferred compensation distributions in retirement.
- If you receive a sizeable annual pension distribution.
Do they inflation adjust the income thresholds?
The Affordable Care Act of 2011 eliminated inflation adjustments from 2011 to 2019. Thus the income threshold brackets will remain the same for a period of time longer. The end result being more and more Medicare recipients will potentially be forced to pay higher premiums as their income slowly increases via inflation and they are pushed into the higher Medicare income threshold brackets.
What are the additional Medicare Part B and D charges by income threshold?
|Married Joint MAGI||Part B Monthly Premium||Part D Prescription Drug Monthly Premium||
Total (B + D) Over Base Premiums Monthly
|<$170,000||2016 standard premium = $121.80||Your plan premium|
Up to $107,000
|Up to $214,000||Standard premium+ $48.70||Your plan premium+ $12.70||+$61.40|
Up to $160,000
|Up to $320,000||Standard premium+ $121.80||Your plan premium+ $32.80||
Up to $214,000
|Up to $428,000||Standard premium+ $194.90||Your plan premium+ $52.80||
|>$214,000||>$428,000||Standard premium+ $268||Your plan premium+ $72.90||
How do I pay for these additional monthly charges above base premiums?
The additional monthly charges will be deducted from your monthly Social Security check. If you are not yet receiving Social Security benefits, you will receive a separate bill for these charges each month.
What if I experience a life event that causes my income to go down?
Social Security will on a case by case basis consider reducing the monthly amount you pay over the base premium for certain life events, such as:
- You were married, divorced or widowed.
- You or your spouse stopped working or reduced your work hours.
- You or your spouse lost income producing property due to disaster or other event.
- You or your spouse had an employer’s pension plan impacted by termination, reorganization or cessation.
How do I confirm how much of a premium I will have to pay?
The Social Security Administration will automatically send you a letter notifying you of any additional amounts above base premium(s) you may be charged for Part B and Part D, with an explanation of their determination.
What if I disagree with Social Security’s decision about my monthly extra charges?
You have the right to appeal any of Social Security’s decisions by doing so in writing and filing a “Request for Reconsideration” (Form SSA-561-U2). You can find the appeal form online at www.socialsecurity.gov/online, request a copy through your local Social Security office, or call them directly at 1-800-772-1313.
5 Common 401k Problems Investors Make
This article was written by a special guest author and colleague, Stephen Reh. Stephen Reh CFA, MBA, CFP® is the founder of Reh Weath Advisors LLC and https://investwithsteve.com/, a fee only financial advisor in Southern California. Stephen is a member of the National Association of Personal Financial Advisors like David J. Fernandez, CFP® and specializes in financial planning and investment advice.
First, I wanted to thank David J. Fernandez, CFP®, your Fee Only Advisor in Scottsdale, for giving me the opportunity to discuss common things I see when looking at investor’s 401k accounts. Similar to David, I help individuals and families with retirement and financial planning needs. One of the areas we commonly see is 401k retirement accounts. Below are some common issues, we run into.
Turning Down Free Money
You would be surprised how many employees say, “no thank you Mr. Employer, I don’t want your free money.” If your employer offers to match your contributions and you elect not to contribute, you literally are giving away free money. Even with 401k’s that have inferior investment menus or high costs, the benefit of the company match will almost always outweigh any negatives the plan might have.
Solution – At least contribute enough money to maximize your employer match. We can help you craft a plan that maximizes your employer match and how it fits into your overall investment plan.
Naïve Diversification / Kitchen Sink / Just Pick Everything
A participant is sometimes knowledgeable enough to know they want diversification and they don’t want all their eggs in one basket. What do they do? They pick everything on their 401k menu. The problem arises in that the person really doesn’t know how much risk they are taking or what they are invested in. If there were a lot of high yield bond funds on the menu, a participant may have way too much risk with high yield bonds. You can also have times where the plan has significantly more stock choices than bonds choices which may result in a portfolio that is not appropriate for the investor.
Solution – Do your research and develop an investment plant that includes sound asset allocation and diversification. Need help creating that plan, contact a fee only advisor and they can help save you time and build an appropriate model for you.
Picking the Winners and Selling the Losers
This one sounds good on the surface but what this means is that you are likely late on buying the funds that have done well and late selling the funds that have done poorly. You also run the risk of having a very concentrated position at the wrong time. If you invested in the top funds in the late 1990s, you likely were overexposed to technology. Prior to the financial crash, if you picked the top funds, you were likely overexposed to commodities and financials.
Solution – Do your research and develop an investment plant that includes sound asset allocation and diversification. Need help creating that plan, contact a fee only advisor and they can help save you time and build an appropriate model for you.
Assuming that Target Date Fund Matches Your Risk Tolerance
The Target Date funds start out aggressive and will get more conservative over time. However, there is absolutely nothing that matches a participant with the risk level they are comfortable with. The match is entirely dependent on either your age or the age you want to retire. If you are conservative and young, your target date fund is likely too aggressive for you and you might panic in a downturn. If you are older and have a high tolerance for risk, you might be disappointed that your target date fund did not perform better. Another common issue I see is a young investor picking a target date fund with a slightly “older” age. The problem here is most of the funds are fairly aggressive until you near retirement. So by picking what you thought was a conservative portfolio, it did not make a difference until decades later.
Solution: Build a portfolio that matches your risk. A fee only advisor like David can help build a portfolio that matches your needs and risk.
Forgetting to Rebalance / Ignoring Your Plan
Some people have not rebalanced for years. By not rebalancing, the portfolio might no longer be diversified and you could be taking excess risk or potentially not enough.
Solution: Check your plan at least annually to verify if it meets your needs. Not sure it meets your needs? Contact a fee only financial advisor such as David to help keep your 401k on track.
David and I help investors every day to build portfolios that will meet their needs and goals. If you would like help making sure your investment plan is on track to meet your needs at a risk level that’s appropriate, give David a call.
Ten Considerations If You Receive An Inheritance
At some point in your life you may receive an inheritance from a loved one or friend. There are a number of issues you should consider first before making any spending decisions:
1 – Don’t rush into any quick decisions
You likely just lost someone close to you and, depending on the relationship, it could be a very emotional time. Relax, take a deep breath. There is no need to rush into making any quick decisions. Now is the time to evaluate and consider all of your options before moving forward.
2 – Diversify
It’s important to diversify any inheritance proceeds so they are in alignment with your long-term financial objectives. The person you received an inheritance from may have had a completely different tolerance for risk than you. For instance, you may have received a concentrated stock portfolio that is too risky for you. Or, maybe you received a heavy fixed income or bond portfolio which does not meet your long-term growth objectives.
3 – Consider taxes before diversifying
If you received after-tax assets (non-IRA), the inheritance likely received a step-up in cost basis. For example, your grandmother may have bought Walt Disney stock decades ago. At the time of her death the IRS gives the inheritor (you) a generous tax break and the new cost basis is the value of the shares at your grandmother’s death. Thus if you wisely choose to diversify your inheritance, there will likely be a minimal amount of capital gains exposure upon the sale of the inherited stock.
4 – Consider distribution options
Tax deferred assets such as an IRA or an annuity typically have a few distributions options such as a lump sum, 5 year payout or annual distributions to be paid out over your lifetime. Unlike after-tax assets, tax deferred assets do not receive a step up in cost basis. Also, most tax deferred assets are typically 100% taxable. Thus any dollar received via distribution will be taxed at your ordinary income tax rate. Depending on the amount of distribution, this could cause a fairly significant tax increase. You will want to work with your financial advisor and CPA before choosing any specific distribution option.
5 – Pay down debt
An unexpected windfall could provide a great opportunity to pay down high interest bearing debt. For instance, if you have credit card debt you may be paying interest in the 20% range. Student loans can also have interest rates in the high single digit range.
6 – Build up a cash reserve
A general rule of thumb is to have 6 to 12 months of expenses held in a liquid cash account. If you don’t have a cash reserve or emergency fund, an inheritance provides an opportune time to create one.
7 – Understand what can happen if you decide to mix your inheritance with the assets of your spouse or significant other
One of the common issues I see is those receiving an inheritance immediately commingle the assets with their spouse or significant other without understanding the ramifications of doing so. To commingle means to mix your inheritance assets with the joint assets of your spouse or significant other. As an example this might be a shared joint savings account, investment account or equity of your home if you were to pay off some or all of a joint mortgage. The concern and risk is that if you commingle assets with your spouse or significant other, and then sometime in the future you divorce or separate from them, you may now be forced to split your inheritance 50/50 with someone you no longer want to be a part of your life. The easy way around this issue is to keep your inheritance assets separate and in your own name.
8 – Do you have children from a prior marriage?
Similar to above, if you have children from a prior marriage, you may consider your inheritance family money with your children. In the event of you pre-deceasing your current spouse/significant other, you can ensure any inherited funds stay within the family and pass to your children as intended by keeping your inheritance funds separate from your partner.
9 – Update your financial plan
Depending on the amount of your inheritance, it could greatly change your financial life. This would be a great time to speak with your financial advisor to determine what changes, if any, will occur in your financial life by adding these additional assets into your total net worth and financial projection.
10 – Have some fun with your inheritance!
I purposefully put this last. It has been my experience that many inheritors start spending right away instead of thinking through all of the above issues. But after you have thoughtfully approached how your inheritance can be used in the most beneficial way to support your life goals, definitely make room for some fun. Go on that long awaited “bucket list” trip, splurge on something you have wanted for a long time, or invest in your favorite hobby.