I’m 40 and my mother just died, leaving me with a $3.25M inheritance. How do I wisely use this windfall to ensure it’ll last me long term?

CBC News reported in February that the Baby Boomer generation is estimated to leave as much as $1 trillion in assets — cash, investments and real estate — to younger generations between 2023 and 2026, with billions more expected in upcoming decades, creating significant windfalls and challenges for those inheriting these assets (1).

Take Rebecca, 40, who inherited $3 million in stocks and $250,000 in cash. She has a $100,000 mortgage and $25,000 in other debt, and, while this is a hypotehteical situation, her wondering how to manage a large windfall to make sure she’s using the money wisely is something that many Canadians will be concerned with in the coming years.

Think before acting

Income tax implications are the first considerations after you receive a large inheritance. Unlike the U.S., Canada doesn’t have estate or inheritance taxes. Instead, heirs can expect the estate to be taxed for capital gains accrued up to the day of the person’s death and are deducted before they receive the remaining amount. Probate fees may also apply based on which province or territory you live in (2).

Beyond the estate’s capital gains tax implications, it’s important to make a smart plan for how to make the money last. Canadian wealth management experts and firms have adopted and referenced the 70/90 rule that illustrates a third-generation curse, whereby “70% of wealthy families lose their wealth by the second generation, and a stunning 90% lose it by the third generation." These experts cite a lack of communication, inadequate planning and low financial literacy among heirs as the underlying issues factoring into this loss (3).

If you want to be the family member that breaks this curse, you should avoid jumping into spending the money or dramatically upgrading your lifestyle.

While in Rebecca's situation, it is probably a good idea to take care of her mortgage and other debt to avoid paying more interest, she should refrain from making large purchases that can erode a big chunk of the money — such as buying a bigger house immediately — and requiring her to commit to higher ongoing expenses.

Something else to avoid is telling anyone other than her immediate family about the inheritance. If word gets out, she may find yourself targeted by people trying to get you to invest in their business venture, help them cope with emergency spending needs or any other excuse to access the funds.

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What should you do with the money?

If you find yourself in a situation where you will inherit a large chunk of money in the near future similar to Rebecca, the first thing you should do is pay off your debt and make sure you build a sizable emergency fund. Then invest every dollar, ideally in a mix of simple and safe investments.

You want to build a diversified portfolio, which means investing in a mix of different kinds of assets so you limit your risk of any one particular asset underperforming and keep costs as low as possible.

Warren Buffett recommends that most people put 90% of their investment capital in an S&P 500 index fund, as this tracks around 500 of the largest U.S. companies and provides instant diversification since those entities are spread across all sectors of the economy. Buffett suggests putting the remaining 10% in bond ETFs, which are fixed-income investments.

Talk with a financial advisor about asset allocation, or what percentage of your portfolio should go into different investments. You can also buy a target date fund that automatically invests your money into a mix of different assets based on your timeline for when you plan to take the money out.

Are you thinking of early retirement? Let's say, like Rebecca, you have $3.1 million in inherited funds after paying off your debt and follow the 4% rule, this would produce at least $125,000 in annual income for you.

With that figure you could certainly retire — but keep in mind the 4% rule only works to make a retirement portfolio last 30 years, meaning your safe withdrawal rate will be lower. You might also consider keeping some of the money for future generations. Consult with a financial professional to figure out when it might be safe for you to give up working.

Article sources

We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.

CBC News (1); Wealthsimple (2); LR Lowthorp Richards (3)