Ask the grumpies: Inheritance advice

Miser Mom asks:

How does a young (20-something) person invest a large, sudden inheritance? Let’s say she just got $300K in life insurance, and is expecting a similar amount in the form of the pension/retirement account that comes with the estate.

She is currently unemployed (or at least, employed only in cleaning out her dad’s home and getting it ready to be sold). She’s guessing she might want to semi-retire on this money.

Our condolences on your loss.

The advice that most planners give for people who have just received an inheritance through bereavement is to do nothing with it.  Wait.  Let it sit in a savings account (or put the bulk in a cd if she think she’ll be tempted by spending sprees) earning very little interest until after she’s done everything she needs to do with finishing up the estate and paperwork and funerals and has gone through a lot of the grieving process.

600K (I’m assuming this is after tax) is not enough for a 20-something to realistically retire on– there’s just too many years of life left, even for someone as frugal as miser-mom(‘s daughter). There’s too many years for (unexpected) negative shocks to happen.  Semi-retiring is a possibility if she’s frugal like miser-mom.  Of course, when one lives like miser-mom, part-time work probably works as enough of an income stream even without the 600K.

This money does buy the time for her to figure out what she wants to do, to take her time finding the right employment (or to try out different employment options), to explore her interests (even get a masters degree) or to wait for something to come along.  It allows freedom and should decrease the stress of unemployment.

Planners generally recommend setting aside a certain amount (anywhere from $500 to 5%) for fun.  For travel or charity or something nice.  She can certainly do that if she wishes.  But she should leave the bulk intact.

My recommendation for what to do with the money after… well, there are a lot of choices.

First, I would pay off all loans, if she has any.  Just because.  Student loans, car loans, housing loans, etc.  Just pay them off.

Second, if she’s planning on staying put, she may want to buy a house.  That may or may not be a good idea depending on what housing prices are like where she is, and if she’s planning on staying where she is or if she thinks she might move for other employment.  If houses are inexpensive and she’s planning on staying put, go for it.  If they’re expensive, or she’s thinking of moving or doing extended travel, then this is probably not something she wants to do.  I’m not a financial planner, so I can’t define “expensive”, but I’d worry about buying a house that cost more than 200K without additional employment income to rely on.

Third, set aside a healthy emergency fund (since she’s unemployed and single, 6 months to a year of spending) someplace she can easily access like savings or a CD ladder.

Fourth, I would want to convert the bulk of the remaining money into an income stream.  There are many ways of doing this.  1.  She can annuitize it, but that’s generally a bad idea for a 20-something since who knows if the company will be in business when she’s 80, so don’t do that.  (Annutities make more sense for older folks.)  2.  She can put 80-100% of it into the general stock market in a broad-based index from Vanguard.  These will spit off quarterly dividends which will be somewhat unpredictable but will have high return and lower risk over a long time horizon (there will be ups and downs).  The remainder would go someplace “safe” like bonds, savings, cd ladders, etc. just in case the economy takes another nose-dive.  3.  She can turn more of her money into income (but with less growth potential) by investing in dividend-heavy funds like utilities.  Vanguard has some dividend-heavy indexes.  4.  She can put it all in bonds (this will have a lower return but do a better job of holding the capital) 5.  She can put it all in TIPS, which is the most conservative thing she can do.  (There are also some riskier options I’m not covering, like lending tree or individual stock investing, but you can read about those on MMM or retireby40.  I don’t recommend those options except as “fun” play money.)

Of these options I would lean towards #2 or #3 depending on how much regular income she thinks she’ll need in addition to whatever she brings in once she finds employment.  If her employment prospects look good, I would go with #2, which will result in more money in the long run but may have some ups and downs.  If she’s less likely to have a steady work income, then #3 will result in less earnings overall, but a steadier stream of income.  She can also put up to 20% of what she has someplace save like TIPS or a CD ladder or even savings, just for that emergency buffer should the economy tank again (she could then draw on this fund while she waits for the economy to recover while dividends are down without having to sell stock in a down market).

Once she does find employment, this windfall is not large enough to obviate any need for saving for retirement.  She should try to hit 401(k) matches if that’s an option, then IRAs, then the rest of her 401(k).

If she finds she enjoys full-time employment and is getting enough money from her full-time employment to no longer need that income stream from stocks, I would recommend to her to move out of utilities (if she chose option 3) and into broader indexes and to set up DRIPs to increase her investments efficiently.  She should also be sure to max out her retirement accounts each year, even if it means converting some of this windfall into retirement savings, to make the most of the tax advantage.

Again, our condolences.  And wish her the best of luck with her future endeavors on our behalf.

Grumpeteers, what would you recommend an unemployed 20-something do with a 600K windfall?  What would you do with it?