For other debt, including mortgages, it is important to consider the interest rate and compare that to an expected investment return. “If the debt is at a relative high rate, say over 5 percent, probably you should consider paying it off,” Schultz says. “But if it is a low-rate mortgage, and you are relatively young with decent employment prospects, you’d probably be better off investing.”
For example, look at the after-tax rate of interest you are paying on your mortgage. “If you are in the 25 percent tax bracket, paying 4 percent on your mortgage, you receive a tax deduction for part of the mortgage, which means you are really only paying a 3 percent interest rate,” Miller says. Compare that to a diversified portfolio of stocks and bonds that could earn 6 percent to 7 percent annually, he says.
Retirement savings. Next in line is investing in your retirement savings accounts. If you haven’t been contributing the maximum to a 401(k) or individual retirement account, do it now. “Say you earn $65,000 this year and spent it all. But now you receive an inheritance of $100,000. Contribute to your Roth or workplace retirement from the $100,000, sheltering some of it from taxes and allowing it to earn tax-free [returns],” Schultz says.
Miller agrees: “In almost all cases, it makes sense to maximize your retirement accounts if your cash flow allows you to do so.”
Have a little fun. Finally, some advisers suggest spending 5 percent to 10 percent on discretionary purchases. “It is nice to treat yourself. List that as one of your goals, and then you can decide if it is really worth it or not,” Minnium says.
Just don’t use a one-time windfall as an excuse to change your lifestyle.Deploying that inheritance wisely can help you climb onto firmer financial footing and lay the groundwork for a more secure future.