Five ways to handle an inheritance

Over the next 20 years, Canadians will inherit $1 trillion. Here’s what you can do with your funds, and why investing with a financial advisor may be your best option.

Canada’s baby boomers and early Generation Xers will soon come into a significant amount of money. Over the next two decades, it’s expected that people born between the mid-1940s and the mid-1960s will inherit a collective $1 trillion from their parents’ estates. Globally, that number is closer to $68 trillion, according to Cerulli Associates.

While those funds could go a long way in helping boomers support their own retirements – an inheritance might also be used to pay off a mortgage or cover a child’s university education, among other things – those dollars will be most useful if they’re saved and spent properly.

So, how should you handle an inheritance? Talking to a financial advisor can help steer you in the right direction. Here are five things to consider.


1. Go slowly

Receiving an inheritance is not like winning the lottery. While you might come into a sizable sum, you’re likely getting it while you’re unfortunately grieving the loss of a loved one. Wait until your mind clears before making any big financial decisions. In the short term, you may want to put those funds into a money market fund, where it can earn some money while you decide. An advisor can help you determine how best to protect your money until you’re ready.


2. Pay down debt

When you’re up for putting those dollars to work, you may want to start by paying down high-interest credit card debt. You can’t get a better return than reducing debt on a card that charges you 20% interest, but make sure to not accumulate more debt after you pay it off. Look at other loans, too, such as line of credit debt or any business loans if you’re an entrepreneur. You might also want to pay off your mortgage, although depending on your interest rate, it may be possible to earn more money in the market.


3. Invest your inheritance

It may be a good idea to invest most of what you receive. Investing in a diversified portfolio of mutual funds or exchange-traded funds can allow you to take advantage of compounding, which is when assets grow on top of gains you’ve already made. (Albert Einstein is said to have called compounding the eighth wonder of the world.) The longer you keep that money in the market, the more chance it has to grow and compound. You can then withdraw later in your own retirement or keep growing it for the next generation. It’s important to invest these funds like you would your other savings – consider your time horizon (i.e., when you’ll need to access that money) and invest in funds that meet your overall financial objectives. A financial advisor can look at your entire financial picture and then help you choose the best investment option for you.


4. Use tax-sheltered accounts

When investing an inheritance, consider using tax-sheltered accounts first. If you have contribution room in your registered retirement savings plan (RRSP), you’ll receive a tax deduction (and reduce your taxable income) based on what you invest. If you’re in a high tax bracket, you could end up receiving a sizable tax refund, which you can then put back into your RRSP. Also consider using a tax-free savings account (TFSA) if you have the contribution room. Unlike an RRSP, any money inside of a TFSA, including gains, dividends and income payments, can grow truly tax free. With an RRSP, you will have to pay income tax on any withdrawals; TFSA dollars can be removed without paying any tax. Deciding which account to use first isn’t easy. An advisor can figure out how much contribution room you have left and which account can help you mitigate taxes best.


5. Help your children

Many people use their inheritances to help their children. If you have a younger child, you can put some money into a registered education savings plan (RESP), which is an account that’s specifically for post-secondary school savings. Contributions can be invested in most types of securities, and they grow on a tax-deferred basis. Tax will have to be paid upon withdrawal, but the money will be taxed in the student’s hands, at what will likely be a low tax rate. Another idea is to gift part of your inherited funds to your adult children for them to use as a down payment on a home. If you want to give that inheritance to your own children after you pass away, consider setting up a trust – there are various kinds – to help mitigate possible estate and probate taxes.

Many boomers are focused on ensuring that the inheritance they receive will last beyond one generation. “Inheritance discussions are shifting to multi-generational legacy discussions as baby boomers are aging,” says Michelle Munro, Fidelity Canada’s Director of Tax and Retirement Research. “Talk to your advisor to make a plan.

There are many other things you can do with an inheritance, such as creating a legacy by donating some of those funds to charity, which can be tax advantageous – and it’s OK to splurge on some of the things you’ve always wanted. However, investing may be the best option for those who want their money to last longer. Put it in a solid portfolio now and then decide how best to use it later, as those assets may have likely grown over time. Whatever you decide, a financial advisor can help you personalize the plan that’s best for you.