My father was having a conversation with our youngest son recently. "When I'm gone, I'm going to leave you the farm," my father said. "The entire farm – including the livestock, crops, tractor, the farmhouse and a few million in cash," he continued. We weren't expecting this news. My son then said: "Wow, Grandpa! Thanks! I didn't even know you had a farm. Where is it?" My father looked at our son and said: "Facebook."
My dad was referring, of course, to the game FarmVille. As it turns out, my kids won't be inheriting a large operating farm from Grandpa after all.
They will, however, inherit something some day.
The most recent survey by Statistics Canada shows the total net worth of seniors in Canada at $2.18-billion. While seniors will consume some of this over the next few years, a trillion-dollar transfer over the next 20 years is a certainty.
If you're due to receive an inheritance soon, what are you going to do with that windfall? I'm going to suggest that there are four key options to consider:
Pay down debt
If you've been paying attention to media reports, you'll understand that Canadians have significant debt.
If you receive cash as an inheritance, paying down debt is a safe option.
If your debt carries an interest rate of, say, 3 per cent, then paying down that debt will allow you to achieve a guaranteed 3-per-cent after-tax rate of return. Not bad. And if paying down this debt helps you sleep at night, even better.
But I will say this: Given that interest rates are at 70-year lows, it's at least worth considering whether you can invest that inheritance and earn more after taxes than what you'll achieve by paying down debt. Granted, you'll likely need to invest in growth equities to beat the debt option, and this comes with risk which needs to suit your circumstances, but you could end up with meaningfully more by investing.
For example, if you were to invest an inheritance of, say, $100,000 at 6 per cent annually (with an equity portfolio deferring its capital gains), you would end up with about $208,000 after 15 years, after all taxes. That is, the $100,000 will have grown by $108,000. If instead you used that $100,000 to pay down a line of credit with an interest rate of 3 per cent, you'd save about $56,000 in interest over a 15-year period.
The improvement by investing is $52,000 ($108,000 less $56,000) in this example, although you had to take on some risk.
Invest the money
If you're far behind in saving for retirement, the option of investing an inheritance needs to be seriously considered – even if you have debt. It's difficult to make up for lost time when your retirement savings have been insufficient, so a shot in the arm from an inheritance can help. This decision should also be impacted by your income. If your income is low or unstable, and your retirement nest egg is small today, investing that inheritance is likely your best option.
On the other hand, if your income is high and stable, you might still want to invest some of that inheritance if your nest egg is small, perhaps along with paying down debt.
Give it away
Using your inheritance to help others can make good sense if your levels of retirement savings and debt are in decent shape. When I talk about giving money away, this can be in two general fashions: (1) to charity to help causes important to you, and (2) to family or friends to help them with needs.
Giving to charity, of course, comes with some tax breaks, so you'll get back some of those gifts in tax savings. Many will choose to give to charity despite having some debt and a need to save for retirement; this is a call based on your values.
Finally, helping kids to pay for an education or with a down payment for a home are common uses of extra cash by parents.
Spend the money
Okay, I'm not going to be the one to tell you that spending part of an inheritance is completely taboo – particularly if your debt is under control, your retirement savings are decent, and you've got a sufficient and stable income.
In this case, go ahead and spend some of that inheritance. A renovation to your home is never a bad idea if it's going to increase the value of your place.
Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.