Spend, save or invest? A financial adviser shares how to put an inheritance to work

Receiving an inheritance or a financial gift can feel a little bit like winning the lotto. It’s easy to have already spent the lot in your head. Some of your plans might be sensible – paying down the mortgage, for example, while others might be a bit of wish fulfilment (that luxury car you’ve always wanted…)

No one wants to just blow up a financial gift, particularly when it could make all the difference to your financial future. Do you spend (be it on paying off debt or a dream purchase), save it or invest it – and where do you start?

If Freshwater Wealth’s Roger Perrett had one piece of advice around an inheritance, it would be to take a moment.

“Stop and get advice. Do the research because it’s very easy to give into the temptation of just paying that debt, or giving the kids some money. You might still be able to do those things but there might be a better way of achieving what you want in a more tax-efficient, and more protected way,” he says.

In this wire, he shared the approach he takes with his clients, and a few things for those who want to pass down an inheritance to consider too.

Planning and researching

Perrett uses a 7-step wealth creation roadmap when he works with clients and he likes to refer back to it when dealing with an inheritance.

It covers making a plan that considers both present situation and future hopes, income needs, tax-efficiency, debt optimisation, sensible investments, asset protection and making gifts and setting your will.

“I want to understand what they’d like to do with the inheritance and how that fits in with their life’s plans,” Perrett says, explaining that this can shift what strategies he might suggest.

For example, if a client wanted to use a portion of an inheritance to buy a boat in the next year, Perrett might put the money aside in a cash account or term deposit. If that client wanted to buy that boat in 7-10 years instead, he might suggest investing the inheritance with the portfolio to more broadly support that client’s longer-term plans. 

He might follow the same plan to invest the inheritance for a client that wants to retire in the next 10 years and has no specific other plans for spending the inheritance, or equally he might look at topping up superannuation.

“I’ll also discuss whether they might need the inheritance for income, should they be using it to optimise or reduce their debts or whether they want to gift any of it,” he adds, noting that he has had many clients want to gift an inheritance they’ve received on to their children to use now.

“The aim is to use the framework to understand the client’s situation and desires, then overlay a number of filters to work out the best way to use those funds,” he explains.

While it often isn’t front of mind, there can also be tax implications involved with an inheritance.

Cash is easy – shares, managed funds and property less so. The biggest thing to consider is capital gains.

“When you inherit investments, you don’t have to pay any capital gains. These are deferred until you sell it, but the trick to keep in mind is that when you do go to sell it, the capital gain isn’t based on since you inherited it, it is determined back when the investment was first purchased,” Perrett explains.

When it comes to property, you have two years from the date of decease to dispose of the property without triggering capital gains tax. Perrett notes that typically properties are sold first and split in the estate rather than being held on to.

To reduce debt or not to reduce debt…

“Debt is hard. The first thing to do is not to pay down debt, but it’s the biggest temptation to be debt-free,” Perrett says.

To be clear, Perrett isn’t saying you shouldn’t pay your debts, but rather to take the time to work through your options first. There is “good debt” and “bad debt” and appreciating the difference affects your financial situation and what you should focus on first.

“Good debt is where there is a debt being used for investment, such as borrowed money for an investment property or to buy shares and the interest the person has to pay is typically tax-deductible. Bad debt is things like the mortgage on your home, car loans or the like where you aren’t generating income and can’t claim a deduction,” he says.

He explains that paying the good debt might actually make your tax situation worse, you should prioritise bad debt first.

“There are a range of options too. You might use offset accounts to reduce your interest payments but then still have available cash for emergencies,” he says.

In the situation of someone with a lot of bad debt, such as credit card debt, he focuses on the debt in order of highest interest rate first and ensuring that the client has enough as a bit of a buffer for their life needs. He might also work with them on restricting credit limits to avoid redrawing on loans.

There are also ways of managing good debt too. Perrett gives the example of a person near retirement and rather than paying off the good debt, they might choose to pre-pay the interest.

Avoiding mistakes

Perrett believes managing inheritances is all about a balance.

“If a client wants to enjoy the money, we’ll help them find the right strategy. But it’s a balance. If they aren’t considering improving their financial situation, we’ll also discuss this with them too,” he says.

Some of the usual mistakes he sees are where the inheritance is simply spent without considering all their options, say making big renovations that don’t improve the value of their home (or actually give them a better lifestyle) or giving it away to the kids without helping their own finances too.

He also cautions that it is important to update your own Will and make sure your affairs are in order – you never know what will happen in life and your estate planning needs to reflect your desires.

Tips for those wanting to gift or leave an inheritance

Perrett has found it common for his clients to want to gift their inheritances early to their children, but there are three things to keep in mind.

1. Protection – for example, if you gift to your child and their relationship breaks down, do you want to ensure the gift remains with your child or grandchildren rather than being part of a court settlement? If so, there are other methods of gifting or helping your child that you may want to investigate.
2. Timing – do you want to gift now or as part of an inheritance when you pass away, and how do you want to structure it?
3. Your own financial situation – Perrett has seen clients be overly generous and it have a negative impact on their own lifestyle. Further to this, you need to consider the implications of a gift on other parts of your finances, such as if you receive a pension.

Spend, save or invest?

The right approach to managing an inheritance, like all things finance, depends on your individual circumstances – but the key is to take the time to understand the options you have and what certain choices might mean for you.

“You can still enjoy your inheritance. Financial advice is about money and achieving your goals so it’s about finding the most effective way to achieve what you want to do,” Perrett says.

A final idea to think about: It’s much harder and time-consuming to earn and save money than it is to spend it, so make it count when you do.