Preparing for retirement isn’t always about stashing a portion of your paychecks for your golden years. For some, it’s about accepting a windfall late in life and trying to make the money stretch.
Let’s say, for example, that you’re 65, single and you’ve just inherited $420,000 from your late mother. Considering that the median 401(k) balance among Americans 65 and over is just $88,488 — and the average balance is just $272,588 — your inheritance sets you up quite well, as that $420K is worth more than what many of your peers have saved for retirement.
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You’re in a good spot, but you’re worried about wasting the money, or burning through it too quickly. And your worries are valid; research from the National Longitudinal Survey of Youth found that a third of people who receive an inheritance either don’t see a change in their wealth or end up worse financially. Meanwhile, another study from Williams Wealth Group found 70% of wealthy families lose their money by the second generation.
That’s the potential bad news. But the good news is, with a few wise money moves, you can make sure your inheritance provides you with long-lasting security.
Choose a safe withdrawal rate
One of the best things you can do to make sure you don’t squander your inheritance is to invest it and withdraw small portions at a time. This will allow you to earn returns, protect the principal balance and keep your money working for you.
There once was a traditional rule of thumb that said you should withdraw 4% from your retirement savings in the first year of retirement and make annual inflation-based adjustments from there. Experts believed this would allow your money to stretch for 30 years or more.
However, research from Morningstar suggests withdrawing 3.7% to ensure your financial situation remains stable. The proposed reduction in the safe withdrawal rate is because people are living longer, and experts don’t think investments are going to keep producing returns at the same rate as in the past.
A 3.7% withdrawal rate from a $420,000 inheritance would provide you with $15,540 in annual income, which is a reasonable sum that you could potentially combine with Social Security and other savings to help fund your retirement.
Since you are single and only have yourself to support, that $15,540 could help ensure that you can afford the necessities like healthcare and housing, while perhaps leaving you a little extra to enjoy in your golden years.
Read more: I’m 49 years old and have nothing saved for retirement — what should I do? Don’t panic. Here are 5 of the easiest ways you can catch up (and fast)
Invest the money wisely
If you decide to invest your inheritance and make 3.7% withdrawals annually, you’re going to need to decide where to put the money. And that will depend on your current asset allocation, as well as how your retirement savings are structured.
One rule of thumb is to subtract your age from 110 and put that percentage of assets in equities, while investing the rest in safer investments like bonds or CDs.
Some retirees also use the “bucket” approach, which involves stashing money in three separate asset accounts:
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Keep a few years of expenses (1 to 5) in liquid assets like cash and short-term CDs.
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Keep money that you’ll use in 4-10 years or so in medium-risk investments that provide better returns, like bonds and income-focused equities.
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Put the remaining money that you won’t use for around 8 to 10 years in growth equities.
You have options, but before you decide what strategy you want to use for allocating your assets, take a look at where your money currently sits. If you already have a lot of money in equities, for example, you may decide to buy bonds or add to your high-yield savings account with the money that your mom left for you.
As you make your decision, remember that there’s always a tradeoff between risk and reward:
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CDs are FDIC-insured and there’s no risk of loss, unless you sell so quickly that you don’t cover early withdrawal fees. However, the returns aren’t as high as with some other investments.
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Bonds are debt instruments and can be safe or risky plays, depending on whose debt you’re investing in. Safe debt, like government debt, essentially comes with no risk of loss but lower returns than other bonds not guaranteed by the full faith and credit of the U.S.
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Stocks allow you to buy an ownership share in companies. There’s more risk since your investment performance depends on the company, but you can use ETFs or mutual funds to buy shares in many different stocks at once to limit your potential losses. For example, an S&P fund allows you to gain exposure to around 500 large U.S. companies.
When deciding where to put your $420,000 inheritance, think about how much you already have in equities, bonds and CDs. For example, if you are already heavily invested in the stock market in your retirement funds, you may want to use some of the inheritance to increase your liquid savings, or buy CDs so you have money to live on without having to sell stocks in case of a downturn.
By investing your money, making sure you have a good mix of assets and taking out the funds at a safe withdrawal rate, your inheritance can go a long way toward setting you up for financial security in retirement.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
