What should I do with an inheritance?

If you’re expecting a large windfall, you might be tempted to ask a friend what to do with it. They’ll almost certainly respond “Give it to me … ha ha!” – the laughter belying their seriousness. Most of us are used to living from month to month and have no experience of handling a significant lump sum. Unfortunately, though, it’s not a situation that elicits much sympathy. “A nice problem to have,” is one of the more benign responses you can expect.

Sudden wealth can be stressful.  A common reaction is to solve the problem by spending it as quickly as possible. The money is gone and we’re returned to the familiar situation of just getting by. An article in The Conversation suggested the average person who receives an inheritance quickly loses half of it through poor decisions. While you’ll certainly want to enjoy yourself with some of the money, don’t neglect the opportunity to make it serve you in the longer term.

In this post, I’ll help you think through the options for making the most of an inheritance, and also point out a few potential pitfalls.

Before you start …

Have you actually received the money? Most estates in the UK go through a system called probate. The Government tots up the deceased’s assets and liabilities, then deducts Inheritance Tax (IHT) from anything left over. Currently, IHT is levied at 40% on estates valued over £325,000. There are exemptions on main residential properties and for spouses, so please read my Inheritance Tax post for more details.

Uncle Norman might’ve left you £100,000, but this could drop to £60,000, depending on how he organised his finances. And if he also gave you money within the last seven years of his life, you could be liable for additional IHT tax, too.

So, don’t resign from your job until you know exactly how much you’ll receive.

Now let’s look at five ways to spend your inheritance.

1. Pump up your pension

Before you help anyone else, make sure you’ve provided for your own future. Check how much money you’ve got in your pension pot and what you can expect to receive from the state pension. Adding a lump sum or increasing your monthly contribution now could ensure a comfortable retirement.

You can only pay a maximum of £40,000 or the equivalent of your salary (whichever is lower) into a pension each year. You should take into account any existing contributions when calculating how much you can invest. For example, if you earn £35,000pa and a total of 10% is contributed through a workplace pension, you could put another £31,500 into a pension scheme.1

There’s also a lifetime limit on how much you can invest in your pension. For the 2019/20 tax year, this is £1,055,000. That might sound a lot, but it’s easy to exceed if you’re a high earner with a generous employer.

2. Give it away

Perhaps you have enough money already and do want to help that importunate friend. Or you’d like to give your children a financial buffer. Again, you need to consider inheritance tax. There are limits on how much you can give away each year without creating potential tax liabilities for your beneficiaries. If you have a large sum to distribute, it’s worth consulting a tax accountant to get expert advice. Also consider whether your beneficiaries know what to do with a lump sum. Will they just blow it? Might a monthly allowance be better?

There’s no IHT payable on charitable donations, so they’ll get the maximum benefit from any largesse.

3. Invest in an ISA

Often, people aren’t sure what to do with an inheritance and just stick it in a cash savings account. Although this is better than keeping it under the mattress, it isn’t a good long-term solution. Not only will your money shrink with inflation, but you might also have to pay tax on the tiny amount of interest earned.

If your lump sum is more than £40,000, you should consider an ISA. You can save up to £20,000 in an ISA each year without paying any tax and there’s no overall limit on how much you can accumulate. There are currently six types of ISA:

Cash is generally a good option if you need to access the money within the next five years. In this situation, you’re prioritising security over growth. Anyone wanting a decent long-term return on their investment should investigate a stocks and shares ISA. This is riskier – your money is exposed to the vagaries of the stock market – but it offers some protection from inflation.

4. Buy a bigger house and live in the suburbs

For most of us, the overwhelming temptation is to buy a bigger or swankier house. Remember, though, that a bigger house could mean higher running costs. Have you saved enough in your ISA to cover those future commitments? And moving to a leafy location might involve a longer commute and associated costs. Is there enough cash to cover all the implications of a larger property?

5. Pay off your mortgage

While a Georgian rectory could be fun, a mortgage-free life might be even better. Paying off your existing debts (and not acquiring any more) gives you additional options. Perhaps you could retire early, reduce your hours at work, or retrain to do something more fulfilling. Mortgages are often described as ‘good debt’, but they’re still debt. Reducing your burden gives you freedom.

Check your mortgage agreement carefully. Depending on your terms, some lenders only allow you to overpay by a maximum of 10% each year. Work out the impact of any penalties and see whether it’s worth drip-feeding the money instead of making a lump sum payment.

Conclusion

Of course, what you do depends on the size of your inheritance and your personal circumstances. Allow yourself time to ponder what’s right for you. Just because this was an unexpected windfall, doesn’t mean you should just spend, spend, spend. It’s unlikely you’ll get impartial advice from friends (and definitely not from family), so look for neutral sources of support. The right decision could mean a secure financial future in which that inheritance works hard for you.

This post is for information only and does not constitute financial advice.

Image © fotofabrika – stock.adobe.com

  1. Including the tax relief you receive. []

Is my money safe in the bank?

It’s not often the Financial Services Compensation Scheme (FSCS) makes an appearance on primetime telly. You might have spotted it in episode two of Russell T. Davies’s futuristic family saga Years and Years. When the Bismay-Lyons family sell their London home for £1.2m, husband Stephen stashes the proceeds overnight in a US investment bank. As the frantic red-flagging suggested, the bank was about to go bust. Stephen – and hundreds of other customers – are shown impotently banging their fists on the glass door. Thanks to the FSCS, his money is protected – but only up to £85,000.

So, what is the Financial Services Compensation Scheme? And what protection does it offer?

The Financial Services Compensation Scheme

Created in 2001, the FSCS is a compensation scheme for authorised financial services firms. The scheme pays compensation to customers if the firm is unable to pay claims against it. Cover is automatic and customers usually receive their compensation within seven days. The financial services covered include:

  • Deposits (i.e. savings)
  • Investments
  • Insurance policies
  • Mortgages

The maximum covered is £85,000 for deposits and £50,000 for investments and mortgages. This is doubled if you have a joint account. If Stephen had put the house proceeds in an account he shared with wife Celeste, they’d have salvaged £170,000 of their money. As a financial advisor, he should’ve known as much.1

Unfortunately for Stephen and Celeste, the temporary high balance provision has been scrapped in the future. Happily for us, it still exists in 2019. This protects people in exactly their position – those who have sold a property, inherited a large sum, or perhaps received an insurance payout. This additional cover applies on balances of up to £1m for a maximum of six months in specific circumstances. Let’s hope Russell T. Davies is wrong in predicting its demise.

How can I protect my money?

Well, firstly, make sure your savings and investments are with companies regulated by the Financial Conduct Authority. This means they’re part of the FSCS and your money is protected. Some investments – notably peer-to-peer (P2P) lending – aren’t covered, so can be riskier than stocks and shares. A few P2P firms have crashed recently, leaving investors with nothing.

If you have more than £85,000 in a sole account, consider spreading it across different institutions (you’re covered up to £85,000 per company, rather than per account). Yes, this is a faff, but it might give you peace of mind. This is especially fiddly with pension pots, where you’re likely to end up with a multiple six-figure sum. If you don’t want lots of accounts, be very careful where you put your money. Be wary of new banks offering seductive interest rates. Instead, seek out established names who’ve weathered previous financial crises.

Conclusion

Although your money is likely to be safer in the bank than under the mattress, you need to be aware of the protection available, and its limits. The FSCS doesn’t necessarily reflect the complex reality of 21st-century finance, where people cash in pensions and keep large sums of money in ordinary accounts. Remain alert to what’s happening in the banking world. This might not be your idea of entertainment, but nobody is more concerned with your financial future than you.

Image © cherylvb – stock.adobe.com

  1. Pedant’s Corner: Celeste tries to transfer the funds to another bank, so I’m guessing this was a joint account. Either the joint allowance has been scrapped in the future, or Russell T. Davies doesn’t find financial planning as riveting as I do. []

Financial Coaching for Couples – what’s it like?

I worked with Adam and Lana over two months in early 2019.  They very kindly agreed to share their experience in an interview.

What attracted you to the idea of financial coaching?

Money has always played a difficult role in our relationship – partly because we have quite different habits and hang-ups around money, and partly because we’ve always had significantly different levels of income.

It ended up causing fights or hostility pretty regularly. Lana, who has less money, would often become anxious and secretive in relation to money, and when she had financial problems she would withdraw rather than talk about them.  That made any discussions relating to money, no matter how trivial, potentially difficult, and led to Adam feeling that he was having to sideline all of his life goals because they involved making big money decisions that would create anxiety for Lana.

What expectations did you both have? Or, what were you hoping to achieve?

We both hoped to understand more about how the other thinks about money, which could help us to communicate better and without creating conflict.  We hoped that this could lead to us being able to combine our finances sooner rather than later.

Lana hoped it would improve her psychological relationship with money, and enable her to take a greater role in us making better financial decisions. She also wanted to be more honest with money. She wanted to be able to take better control of her personal finances, and not feel resentful about spending money she couldn’t afford.

Adam hoped he could get some advice on things like pensions, wills, inheritance and life insurance to enable him to start putting plans in place for all of those things.

What aspects were most useful?

For Lana, understanding how she feels about money and why she behaves the way she does was incredibly useful – that’s helping to create an underlying change. For Adam, it was helpful to be able to talk about his fears of what might happen if we didn’t start making positive money choices, for example, if we put off getting a mortgage for too long. He also found it helpful to be able to understand and listen to Lana talk about her relationship with money, and to help her feel more confident and supported. He can also trust her to make good financial decisions now, whereas before he felt like she might make bad choices. We both came away feeling much stronger as a couple and like we were on the same team.

Were there any surprises or unexpected outcomes?

The big surprise for us was that it led to us wanting to get married! We realised that if we could manage to join our finances, then we could manage to join our whole lives.

Did you find any aspect of the process challenging?

Adam didn’t find it challenging at all, because Catherine made the atmosphere so welcoming and relaxed. Lana still found it a bit emotionally challenging at times – it brought up some tough feelings and memories, and it meant having some difficult negotiations about where her lines were. But it was still so much easier to do this in a guided and productive environment than to try and do it alone.

What are you doing differently as a result of financial coaching?

We’re going to stop paying for everything 50/50 and start sharing most of our money. We’ll contribute towards our rent and bills in proportion to the size of our individual incomes, and both have our own personal spending money as well. Lana has also set up a Monzo account which is helping with budgeting, and a high-interest short-term savings account. Longer term, we’re making plans to get a mortgage together.

Do you have any tips for other couples on managing finances?

Communication is the important thing, because there’s no one right or wrong way to do money. The thing is, it can be really hard to communicate effectively – that’s why a financial coach is so helpful. They create a very friendly, non-judgemental environment, know which questions to ask and make sure that both of you are listened to. We both felt like we understood each other and ourselves better, and we worked out our problems so much more quickly and harmoniously than we could have done on our own – if we could have at all!

If you’re interested in financial coaching for couples, please get in touch.

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