13th February 2019
‘What should I do with an inheritance’ or ‘How to invest an inheritance’ are questions we might never hope to need to consider but many are forced to answer every year here in Ireland. This week in Ireland’s award-winning and unbiased finance Blog & Podcast I hope share some insights which might be of value to anyone that does every find themselves faced with this question. The reason I guess that this is a relevant topic here is because I have seen several cases where people inherit money, then act irrationally or in ways that is to their own detriment, and they end up blowing the lot on senseless stuff that they wound up regretting a short time later. That is hardly a respectful way to behave with the likely hard-earned legacy that a loved-one has left you!? Likewise I have seen some people handle it really well and have made decisions that have supported their goals, and the result being the inheritance was a positive impact on their life. Surely, a better outcome! I’m out to help even a handful of people to avoid that same regret.
Take Some Time:
While it may seem like an obvious point to make I do believe that following the death of a loved-one and the inheritance of a large sum of money it is only wise to take some time to grieve and come to terms with your new situation. Indeed the Central Bank concur and list recent survivors and beneficiaries as potentially ‘vulnerable customers’. Ultimately this means that under the Consumer Protection Code (CPC) an advisor is obliged to offer you certain protections if you are in this circumstance, such as offering you to take time before making an investment decision and inviting another person to the meetings they might have with you. It is claimed that the period of time it typically takes for probate to be completed and the estate to be distributed can take from 10 to 48 weeks, so you might not have the option other than to take your time!
Irrespective of what you are planning on doing with the money you are likely going through a period where you may be grieving, where you are unsure of what they future holds and what your priorities are. That is no time to be making a big decision. There is no rush, take some time. Making the decision now or in 3/6 months from now will make little or no difference so slow it down! Whether it is enforced by regulation or by your own common sense it would be borderline irresponsible to make a decision about what to do with these funds until you have had time to process it and weight up all the aspects for yourself.
So, What Can I Do With An Inheritance?
Right, so now that you have taken some time it’s a good spot to be thinking about what your priorities are, and what needs you have coming up over the various time-horizons. Consider what short, medium and long-term needs you will have and aspects of life that are of priority for you. Here’s some of the main ones that we might see:
1) Paying-Off Short-Term/Unsecured Lending: These are the loans and hire-purchases on which you might be paying the greatest levels of interest on, and are therefore the most costly to have against your name. Usually a car loan, or credit card carry the highest levels of interest and are therefore most often in the firing line.
2) Clearing Your Mortgage: If you already have an existing mortgage then there is always a temptation to clear some or all of your mortgage off. Not a crazy idea by any means but once you hand it over to the bank you don’t get that money back for future endeavours! We covered this topic in detail here in Blog17 a couple of years ago, the fundamentals are still solid. Some folks have really low mortgage rates which make it less than super value to clear the mortgage versus aiming to keep the money and achieve a rate of return. There is no fundamental right or wrong answer for this question, it will boil down to personal preference and an educated estimate on the financials.
3) Put It Aside For The Future: You may have no need for it now, have no other potential use for it, or have a grá for building a considerable nest-egg for the future. If you are in one of these boats then you need to now consider how best to squirrel it away. Some good questions to ask yourself could include; what rate of return are you aiming for? What period of time do you want to invest it for? How much volatility can you or are you willing to withstand in order to try achieve a decent real rate of return? Will you need ANY access over the years, and if so how much access will you need? If you are at all unsure of how best to proceed it might be time to hire a credible advisor to assist in your decision-making.
4) Give It Away: This might seem like a silly option but it is undoubtedly one of the options available to you. Perhaps you have a worthy cause in mind that you would like to support, perhaps you have a friend of family-member that would benefit in a life-changing way from a gift of some or all of the windfall you have inherited. Likewise you may not, and you may feel that giving away a windfall is the equivalent to looking a gift-horse in the mouth…..horses for courses (2 horse metaphors in 1 sentence, wow!).
5) Spend It: Yep, it’s an option too! You could very well decide that there’s no time like the present, that life is for living and that to heck with all the future planning or gifting, that you are going to reward yourself with something sweet right now! A car, a holiday, a desired experience, a new house, an extension or whatever might be top of your list.
How Best To Allocate An Inheritance:
In reality the above are all viable options, it purely comes down to personal preference, but if I was in a position where I was earning a decent income, had some disposable income each month, had a reasonable mortgage at standard rates I would probably consider a combination of various options from above. For example if I inherited €300,000 I may decide to use a portion (€100,000) of it to reduce my mortgage. In this regard I would probably decide to instruct the bank to reduce the term remaining as opposed to reduce the monthly payment, meaning that the mortgage may be cleared well in advance of me reaching normal retirement age. I may decide to set say €50,000 aside for an emergency in the future (assuming I don’t already have an emergency fund of 3 to 6 months of household expenses stashed in a deposit type account). I may also decide to live a little right now, maybe taking some unpaid time out of work to enjoy a 2 month holiday that I have always wanted to do, call it €20,000 including the time out of work. We have now allocated €170,000 of the €300,000 and we have already ticked the ‘pay down some debt’ box, the ‘set some aside’ box and the ‘spend it’ box, and we still have €130,000 remaining.
At this point we may decide that we want to give some to a worthy cause or loved-one to help them along in some meaningful way. Otherwise we are looking at ways of setting this money aside, ensure it’s value at least keeps up with inflation and that is in line with my long term needs and goals. I really should avoid investing in something unless I have a clear plan for it, that there is some purpose behind my investing. Fail to plan, plan to fail.
How To Set Money Aside:
If you do decide to set money aside for some future use, or use in retirement or whatever future goal you have then I guess there are a few key ideas that are worth considering. Inevitably you will need to decide where you are going to put that money for that period of time. As a broad rule of thumb I suggest that unless you can comfortably afford to leave your money invested for 7 years or more then you are best-off not investing in something like an equity-based lump sum investment option. The reason? Well as we covered in Podcast55, if history is anything to go by the likelihood of your returns being positive increase dramatically the longer you can leave the money invested, irrespective of whether you invest at what turns out to be a peak, or a trough.
Another drum that I always bang here is the need to make sure you get value for money if you do decide to invest. There are a large number of investment products stating that the annual management fee is 1% or 1.5% per year on what you invest. However there is an equally large number of such products with murky additional charges in the back-ground that can drive your total costs of ownership to 2.5% to 3% per year. That is a significant price to pay for any such investment every year, and can eat into any potential returns you achieve over the long term. Check the investment ‘Key Information Document’ (KID) to see the impact of charges on your plan over different terms to get a handle on this prior to jumping into any investment. Check out Blog 45 from a year ago to see how high fees impact on your investment over the long term.
Another aspect of investing that is worth noting here is the need for a plan, to determine how much return you actually need. It may transpire that you don’t need to achieve any growth at all, that a deposit account or similar might satisfy your need for return. If it doesn’t and you decide to invest in say a ‘moderately risky’ (I call it volatility not risk but that’s an entirely different topic!) in the hope that it will deliver 4-5% per year growth. It may be a ‘balanced’ investment and contain a blend of equities and bonds or other assets. Again, what is the point of investing if not to achieve significantly better returns than otherwise available, right? So if we play this forward, and the investment achieves it’s 5% return. You will pay 40% tax approx on the gains of such an investment generally, which cuts your net returns from 5% to 3% or so. If you are paying fees of 1.5% on such a product (being optimistic here) you’re real net return is now 1.5%. If inflation stays at the current rate of 0.4%, you will have achieved a net ‘real return’ of 1.1%. 1% return each year. In the grand scheme of things this is probably a little disappointing, particularly as you have invested in a product which to be fair carries a reasonable level of volatility, all in order to achieve 1.1% net real return each year………………really?!
There is a school of thought that suggests it is not worth while investing unless you are going to invest in a portfolio that is mostly equities, which have historically delivered 8-11% depending on the type of equity, and which even after taxes, inflation, and more favourable fees would have delivered real net returns of 5 times what the above example had delivered. However, if there is a danger that you can’t hold your composure in such a portfolio, where annual declines and ascents can be extreme, it is usually best to avoid it entirely.
What To Do If I Inherit Property?
The above examples have in fairness made the assumption that you have inherited cash, which makes things relatively straight-forward. If you inherit property it is obviously less clean-cut in terms of your options and ability to allocate resources to various priorities, you can’t split a house! Having said that inheriting a house gives you options that inheriting accessible cash does not.
1) Sell it. You can obviously decide to sell the property, bedamned with the managing of the place, and the potential hassles with tenants, annual tax returns or whatever other rationale you may have for putting it on the markets. There are things which can get in the way of this obviously, such as a sentimental attachment to it, it may be a particularly bad time to try to sell a property, and if you do you’ll perhaps get less for it than you believe it worth. If however you do succeed in selling it at a fair or favourable price then it allows you the above options.
2) Rent it. You may decide that to you it represents a very handy additional incomes source if you rent it out to tenants. You hereby become a landlord, if not previously you must register for income tax and with the Private Registered Tenancy Board (PRTB). You will likely pay tax on a sizable portion of your income, provided you can rent it out. We are living in an environment at the moment where most properties are very easily lettable, at relatively high prices, but it is not always that way! Check out Blog 17 for insights on the details of land-lordship.
3) Live In It. The third and final option to do with property is obviously to live in it! You may already have a home, which if you sold with some equity attached you could release a lump sum of cash. If you didn’t you might now have a home that has no mortgage on it, allowing you to live in a home and not have one of the single biggest expenses that most households face, which is a fortunate position to be in for most. Depending on your circumstances you might even decide to rent one or two rooms of your new property and also live there yourself. Under the ‘rent a room relief’ you may be entitled to receive €14,000 per year in rental income from letting out rooms in your home, and pay exactly zero tax on that income. If you are a higher rate tax payer it is the equivalent of earning an extra €2,000 per month, or €24,000 per year Gross. It is a very generous allowance no matter what way you slice it, provided you don’t mind sharing your fridge, kitchen, sitting room and bathrooms!
I guess it is at this point that most blogs would tell you to ‘get in touch with me today’ and I will help you to make the best decisions for you . However I do firmly believe that you should try and figure out your own priorities and goals first and foremost. A financial advisor usually won’t know what is best for you personally. Perhaps a really skilled coach or planner might be in a position to ask you the right questions for you to figure out your own priorities, but they can’t make the decision for you! It is for that reason that I always encourage people to consider it for themselves, and once they have some concrete ideas in terms of how they want to allocate their windfall to then engage the services of an independent and credible financial advisor to figure out some of the more technical aspects before making a decision.
Whoever gifted you this inheritance more than likely worked hard, managed the asset appropriately and therefore was in a position to pass it to you as their legacy, I believe the least we can do is to treat it with the same respect, and to avoid some of the most common and costly mistakes. Good luck!
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Thanks for reading.
Paddy Delaney QFA | RPA | APA | Coach
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