Q. Obviously one does not want to count on an inheritance, but like Social Security, believing it won't be there may lead to working longer/harder than needed. How do you think someone expecting an inheritance should factor that into their financial planning?
A. I've written before about what to do with a windfall. However, what to do with an inheritance is more about a possible future windfall, which is a very different thing.
3 Factors to Consider When Including an Inheritance into Your Financial Plan
#1 The size of the inheritance
#2 When you are likely to receive the inheritance
For example, if you plan to retire with $5 Million and the inheritance will be $100,000 and come about the time you retire, you should just ignore it. It isn't going to materially affect your financial planning. But if the inheritance is $2 Million and will come before, at, or shortly after retirement, then that's too large to ignore. Likewise an inheritance of $200,000 that you'll receive before age 50.
#3 How likely will you receive it
The real sand in the gears in this calculation is how likely you are to receive the inheritance. Lots of things can happen to an inheritance. You can have a fall-out with the person you thought was going to leave you money. That person could also live longer than expected, or burn through a bunch of cash treating his terminal illness. The person could also be a poor investor or be taken advantage of by an unscrupulous professional, making that inheritance much smaller than you were expecting. Some parents leave different amounts to children depending on the children's various financial situations. If your parents are like that, expect as the high-income professional in the family, to get a smaller chunk.
The Easiest Thing to Do With an Inheritance
The easiest thing to do with any possible inheritance is to just count it as gravy. That means if it comes, great. If it doesn't, that's fine too. That means that the money you inherit should be earmarked for charitable contributions, leaving as your own inheritance, or at least only counting on it for extras rather than mandatory living expenses. You still need to work, save, and invest until you have enough to retire comfortably without the inheritance.
The “Sure Thing” Inheritance
Let's say you're 40 years old, have a retirement nest egg of $500K, plan to retire when you hit $5 Million, and expect an inheritance of $1 Million to show up at some point in your mid-50s, give or take 5 years. Let's say you are saving $50K a year toward retirement. If your investments earn 5% real over the years, you should be able to retire at 68 as seen in this spreadsheet function:
=FV(5%,28,–50000,–500000,1) = $5.03M
So, what happens if you add in a $1 Million inheritance at 55? Well, let's first run that equation for just 15 years:
=FV(5%,15,–50000,–500000,1) = $2.17M
Now add $1 Million to that pot and you can run this equation:
=FV(5%,13,–50000,–2170000,1) = $5.02M
Essentially you've cut 5 years off your career with this inheritance. But what if you still wanted to work until 68, how much less could you save each year? Well, it turns out you can save much less, about $20K a year. See, your first 15 years looks like this:
=FV(5%,15,–20000,–500000,1) = $1.49M and then you add your million dollar inheritance and your next 13 years looks like this:
=FV(5%,13,–20000,–(1000000+1490000),1) = $5.07M
Talking to the Folks
This one better not be counting on an inheritance when I keel over
Perhaps the best thing to do is to actually talk to your parent or whoever you expect the inheritance from and tactfully (very tactfully) ask if an inheritance is something you should incorporate into your financial plan. Perhaps you'll be able to then have a general idea as to the amount and liquidity of the asset. You can then run the person's stats through an online life expectancy calculator to get an idea about when you'll receive the inheritance.
Have I done this? Heck no. I help my parents manage their portfolio. I know how much is there, and divided by their 6 kids it isn't going to dramatically affect my financial situation, although it could be a significant boost for some of my siblings with smaller retirement nest eggs. But I anticipate being well into retirement before the last of my parents departs this Earth. I'll need to have “enough” before they'll have had enough. Besides, my mom reads my blog so if she wants to tell me how much I should expect in the will, I'm sure she will. I've already told my siblings I'm taking the rocking chair Grandpa made no matter who my parents leave it to!
The Bottom Line on Inheritances
If you're sure you're going to get an inheritance, sure about how much it will be, and sure about when you're going to get it, then factor it into your retirement plans (always adjusting as you go of course.) I suspect that's a very small percentage of inheritors, however. Most of us don't know how much money we're going to inherit, when we'll get it, and cannot even be 90% sure, much less 100% sure, that we're actually going to get it at all. If that's the case, I'd ignore it for your planning purposes and use that money for your charitable giving, your own inheritance, or your “gravy money.”
What do you think? Do you expect an inheritance? How much and when? How has the knowledge of knowing that is coming affected your retirement planning? Comment below!
I wouldn’t count any chickens before they hatch.
If you ignore the potential inheritance, the worst that could happen is you have “too much” money or retire a bit sooner than you would otherwise. If you plan around it, and the inheritance doesn’t come to fruition, you could be putting yourself in a tough spot.
Excellent analysis. The only “sure thing” I can come up with is if you happen to be a beneficiary of an irrevocable trust. In that case, it might be feasible to ask for a copy of the trust document, which will stipulate how the trust corpus (investments and real estate, typically) is to be managed and distributed.
Two random comments… but on point! (Sort of.)
A remarriage of the parent or grandparent with the money one expects can in one fell swoop eliminate an inheritance. (I’m philosophically opposed to prenuptial agreements except in case of blended families created later in life for just this reason…)
If you have enough money that the inheritance won’t matter, disclaiming the money so your kids get it seems worthwhile to consider. E.g., while I don’t anticipate any inheritances, should I receive one I would disclaim to my kids since it would matter a lot more to them than to me.
Living life with the expectation of receiving an inheritance decades into the future is very week. Make your own future and your own wealth. Expect the people you love to spend money on themselves in retirement. Actually you should encourage them to spend that money and enjoy their golden years.
Once said inheritance is only a few short years away then maybe you can re-evaluate your financial situation. Until then live your own life.
Over the years my parents have saved a reasonable sum of cash. They are retired and I constantly urge them to travel and enjoy their free time to their utmost. I would be thrilled if my inheritance was spent to almost nothing.
This is sort of a related but perhaps morbid question. Would you consider taking out a 20 year term policy on your parents with their approval and pay the premium on their behalf and then the fund can be dispensed to a trust.. can be given to kids or grandkids? I checked on term4sale.. for a 65 male 20 year policy, healthy individual.. about $5-5.5k annually.
for a $500,000 policy.
Interesting idea. The downside is if they outlive the 20 year term, you would be out 100 to 110K.
You could do it, yes.
Why would you want to do that? No need to pay the premium for insurance unless there are dependents. Seems rare that someone would be “dependent” on an inheritance.
The question was “could you do that” not “should you do that.” I agree it isn’t necessary and I’d have to spend some more time thinking about it to see if I thought there was a time when it would be a good idea. Maybe if you know something about their health that the insurance companies won’t discover. I don’t know.
Never use as an excuse my spouse will inherit big bucks so I do not need to save for retirement!
I think it is very dangerous to consider an expected inheritance as a part of your financial plan. You never know if they could spend it, lose it, or disinherit you. Most importantly, I feel everyone should make it on their own.
Thanks to diligent saving and investing, we could retire today financially. Since I am planning on working another fifteen years or so, we should be in good shape. I expect to inherit 10 plus million dollars from my parents down the road. It is not part of my financial plan. I wish they would spend more of it on themselves since they earned it. Since they are not spenders, I am starting to prepare for that eventuality. I have had preliminary discussions with them about their favorite charities and causes. I would like to honor them by donating a good portion of it to causes that are meaningful to them.
I have also seen how an expected inheritance has ruined individuals and families. People get lazier about making it on their own and argue about trivial amounts of money. Relationships can be ruined. It is terrible to see adult children feel entitled to their parents money and get upset when their parents live longer spending more of “their” money.
I think it is best to not consider an expected inheritance a part of your financial plan. You will be better off.
most of our children will received inherited iras that hopefully they can stretch over their lifetime
Some talk of stretch IRAs going away. James Lange seems to be under the impression that it will definitely happen, it’s just a matter of time.
My parents love to talk about their plans for our inheritance. Dad was a dentist, turned real estate broker and developer. Although a somewhat dark topic, they seem to look forward to one of them passing away (dad is 89) since they say it means a step up in basis.
The adult children all shake our heads and smile, since they like discussing the topic. As per WCI and the prior posts, I’m not counting on it, and if it comes, then it’ll be gravy and not crucial to my financial plans.
Maybe we should see a post about what to do with a life insurance payout ( say, $1 mil) – like bullet points: a) pay off the mortgage, b) fund the kids 529’s etc. in the unfortunate event of us passing, so we can just print it out and give to the significant others as the “Valkyrie Plan”- I’m sure it would be much appreciated by a wide audience of WCI
The answer is different for everyone, but having a piece of paper of “What to do if I die” is a darn good idea.
I expect to receive an inheritance about the size of my financial independence goal, but am not counting on it.
The one change, or at least possible change, I have made based on this likelihood is to maintain an aggressive asset allocation.
Conventional thinking is to decrease the proportion of stocks and increase bonds as you age, perhaps using a rule such as 110-age as the % in equities
Since I will likely accumulate more than enough to fund retirement on my own (happy with current lifestyle, really enjoy working) and will probably get this inheritance, I feel I am mostly investing for my kids (and hopefully grandkids) and charity and with a longer time frame there is no need to increase the bond % and decrease volatility.
I haven’t seen much written about this, but this would seem to be generally applicable (surely Warren Buffet and Bill Gates aren’t increasing their bond % as they age).
Sneezy, Have you read the 2-part bond series in Physician on FIRE? http://www.physicianonfire.com/bonds1/ and http://www.physicianonfire.com/bonds-good-part-ii/
I had not but will
The no bonds argument seems to contradict the efficient frontier, which I thought was a cornerstone of modern portfolio theory, but I will read the articles in detail and comment at your blog
I had been trying to limit myself to one personal finance/investing blog but will make an exception at least this one time 🙂
These articles discount the tremendous psychological benefit of volatility smoothing in retirement.
buffett and gates are not to be compared to
conventional thinking is to increase BONDS to PRESERVE LIFESTYLE
Interesting article on a very hairy topic. Most states today prohibit anything resembling a transfer of rights in a decedent’s estate before such decedent has actually died, for good reason. Further, the inability to sell your right of inheritance has been a legal axiom for hundreds, if not thousands of years.
The good advice is to never count on an inheritance. Realistically you might do a little arithmetic in your head about what might happen one day and what you might do with the money, but anything more than that is particularly toxic, for a myriad of reasons, not limited to:
1) Obviously, if you factor it in as part of your plan, a substantial portion of your plan could literally vanish at the whim of a person who is likely elderly and prone to suggestion.
2) Very, very often children vastly overestimate the size of their parents’ estates. You would have to be very involved in a parent’s finances to have a clear picture of their net worth and what might pass to you. Many seemingly wealthy parents will go to great lengths to conceal debt and to continue to portray a luxurious lifestyle.
3) What might seem like a large estate can quickly dwindle in later years as medical and nursing bills mount, needy family members glean money away, parents develop gambling or other spending habits or become susceptible to scams and poor financial advice.
4) You’re quite literally placing a value on your parents’ deaths. While we do this everyday with things like life insurance, etc., we typically do not factor life insurance payouts as part of a retirement plan. Basing your retirement plans on an expected inheritance not only creates a long list perverse incentives, but it can also foster resentment among children who may feel strung along while they watch their parents squander money that the presumptive heirs believe already belongs to them.
Your model is adorable 🙂
Well paid, too.
Haha, all the better!
Hello Mr. White Coat Investor.
Just thought I’d ask for your input, as your article directly relates to my situation. Although some may find the money topic with their parents to be taboo, my mother and I are very open about it. My father passed away at 77, 14 years ago, and owned a couple income properties. My mother had/has no financial wherewithal so I advised her to sell them. There was a couple hundred thousand dollars in stock holdings as well. The total amount was about 1.8m. She did not want to pay someone 2% to manage the money and asked me to do it, knowing that I have some stock investing background. I invested most of it in diversified bonds and fixed income assets. The stock account was liquidated in 2007, but I put everything in the market, using diversified ETFs, in March 2009, when the market was down 50%. The value has increased from 275k to 1.2m. The total value of the stock and bond portfolio is now 2.75m. There is also a house worth about 1.9m, less a 300k mortgage. Today, I’m the only one who controls the investments, with full POA. I also have a copy of the notarized trust document between my father and mother and can verify the estate will be split 50/50 with my brother. There are no other restrictions and we are both in our mid 40s. My mother is now 85, single and deteriorating. She has the best health insurance possible through the state of California and pays nothing for any services. She also bought a long term care insurance policy 12 years ago along with an umbrella policy to protect against litigation. She is well covered against any foreseeable or unexpected outcomes.
I have about $350k in my own accounts, mostly taxable and 70k in a roth, along with $1k/month in guaranteed income. The current value of the entire estate is a little over 4m. I’d say a 2-2.2m inheritance is a sure thing, give or take a couple hundred thousand. Obviously the timing is unknown, but likely less than 10 years. I’m definitely not looking forward to her demise, but I know this is an inevitability. My biggest goal is minimizing any discomfort and keeping my mother happy during her last years. At the same time I’m completely miserable in my profession and need an exit. I’m considering hanging it up and relocating overseas to a lower cost country, where I can mitigate expenses. How would you approach this financial perspective, given the expected future inheritance and current level of personal assets?
Depends on how much you spend, but if you don’t spend more than $100K a year, you’re probably already FI if you count that inheritance. So you can really do whatever you want. But honestly, you’re 40 and miserable in your work. Why not find work you like and transition there? Given the $350K you have and backstopped by a $2M inheritance, you can transition to anything you like.