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How to Invest an Inheritance for a Comfortable Retirement

Inheriting a large sum of money can be a blessing or a curse, depending on how you approach it. When your net worth takes a significant leap overnight, that creates new opportunities, financially speaking.

At the same time, there are new challenges associated with managing newly acquired assets. If you've recently inherited a windfall or you're set to in the near future, here are the most important things to keep in mind when you have your eye on a comfortable retirement.

Take your time. Rushing into decisions when you're received an inheritance is a strategic error you can't afford, says Brad Thurber, senior vice president and financial advisor with D.A. Davidson & Co. in Salt Lake City.

"The biggest mistakes made by new heirs generally come from impatience," Thurber says. That can backfire if the end result is needless spending or poor decision-making.

Divam N. Mehta, a certified financial planner and chartered financial consultant with Mehta Financial Group in Glen Allen, Virginia, says that often, people mistakenly treat an inheritance as if they've won the lottery. Without a plan in place, the odds of squandering those assets are increased.

Keeping your emotions in check is vital to your financial well-being when an inheritance is on the table, says Kathleen A. Grace, a certified financial planner and managing director with United Capital Financial Advisers in Boca Raton, Florida.

"Many who receive a financial windfall are caught in the euphoria of the moment, and they often make terrible money decisions," Grace says.

[See: 13 Ways to Take the Emotions Out of Investing.]

Her advice? Take time to fully grieve and mourn the loss before making any significant moves.

Evaluate where you're at right now. Tony Hellenbrand, a retirement income certified professional and partner at Fox River Capital in Appleton, Wisconsin, says it's important to understand what your starting point is as you shape your plan.

"Revisit your own financial picture," Hellenbrand says. "How much is in your emergency fund? When's the last time you reviewed your estate plan? You need to know where you are and what your goals are to have any hope of making a wise decision with an inheritance."

Beyond financials, you need to consider your age, Mehta says. Someone who inherits money in their 30s is likely to have a much different investment strategy compared to someone who's inheriting assets in their 50s.

If you have debt, such as student loans or credit cards, those also have to be factored in, Grace says. The same is true if you have a mortgage. From there, you can move on to determining what the best strategy is for investing an inheritance to create income in retirement.

Know what it is you're inheriting. Assuming that all inherited assets can be treated equally is another common misstep that can impact your investing plans.

Jennifer Myers, a certified financial planner and president of SageVest Wealth Management in McLean, Virginia, says there are certain questions heirs should be asking about an inheritance so they understand what it is they're getting.

"Inheritances can come in all different shapes and sizes," Myers says. "The size element is easy but the shape element is far more complicated."

If an inheritance is coming your way, you need to know things like whether it will be paid outright or held in trust. When a trust is involved, you should be clear on who the trustee is and what stipulations there are for accessing the money.

The form the inheritance takes is also important. The way you would handle a lump sum of cash, for example, may be very different than if you're inheriting real estate, a financial interest in a business or qualified retirement accounts, such as a 401(k) or an individual retirement account.

Map out your comfort zone. Deciding where and how to invest an inheritance depends largely on your risk tolerance, says Rhett Wood, an independent insurance agent and investment advisor representative at Bertrand Retirement Solutions in Oklahoma City.

According to Myers, this is another area where emotions should be set aside so the focus stays on your financial future.

"Sometimes people feel like they can be more aggressive with an inheritance because it's new-found money. Alternatively, sentimental attachments can cause them to be more conservative if they're worried about losing an inheritance," she says.

[See: 20 Awesome Dividend Stocks for Guaranteed Income.]

Once you're ready to begin investing the money, look at where those assets are being allocated.

Scott Sanders, a certified public accountant and managing partner with Sanders, Thaler, Viola & Katz in New York, says to look at your investments in the context of overall market conditions. "Historically, returns for stocks, bonds and cash haven't moved up and down at the same time," Sanders says.

By investing in more than one asset category, you can reduce the risk of losing money. Even if one part of your portfolio lags, you may be able to counteract losses if the rest of your assets continue to perform.

Pay attention to the tax implications. Inheriting money without considering how it could affect your tax liability is a costly mistake that can shrink the amount you have available to invest, according to Anthony D. Criscuolo, a certified financial planner and portfolio manager with Palisades Hudson Financial Group in Fort Lauderdale, Florida.

"Depending on the type of assets you inherit, hasty action could mean handing over a substantial portion of your inheritance to the tax man," Criscuolo says.

The key is to pay attention to whether the assets you inherit are retirement accounts, advises Christopher Pegg, a wealth planning manager with Wells Fargo Private Bank in Del Mar, California.

Traditional IRA and 401(k) assets are treated as ordinary income upon distribution. If you can delay distributions from those accounts as long as possible, that allows you to defer paying income tax on the assets. Cashing out an IRA can open the door to a bigger tax bill if you're not careful, Wood says.

David Twibell, president of Englewood, Colorado-based Custom Portfolio Group, recommends meeting with a tax expert as soon as possible when an inheritance becomes part of your financial reality.

[Read: How to Give to Charity and Pay Less in Taxes.]

"The amount you'll pay in fees for a tax consultant pales in comparison to the money you could lose if you don't handle the inheritance correctly," Twibell says.



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