Receiving an inheritance or large financial gift can be an overwhelming experience at any age – but especially when you’re young. Most people passing on a large sum of money want it to make a positive impact on your life. This is a good thing, but it can also be a cause of friction if you’re seen to waste it. And the responsibility of spending the gift wisely may feel like a burden.
The best place to start is by talking. The taboo attached to money means that we often avoid discussing it, but it can be extremely beneficial to ask the person planning to give you money how they would like you to use it. If your parents are giving you a sum to reduce their inheritance tax bill while still alive, talk directly to them; if a grandparent has left money in a will, talk to other members of your family or those who knew them well. It may be useful to talk to a financial adviser – your parents may already have one with whom you could arrange a consultation.
Often, the primary aim of a gift is to help the recipient achieve financial independence. That can mean freedom from debt, owning a home outright and having enough income to meet your needs for the rest of your life. Few inheritances meet all these needs – in fact, wealthier parents often worry that delivering this will take away their children’s motivation for work and may even harm them.
Step 1 – Freedom from debt
Before you begin to spend, take care of any immediate debt. This could be as small as an overdue electricity bill or as substantial as years of credit card debt that you’ve been racking up since uni. Credit cards are especially important to pay off, as interest rates are usually very high. They are also easy to forget about or disregard, so really scrutinise your accounts for any lingering debt.
There’s a caveat to make when discussing debt – student loans. Your student loan is a different kind of debt entirely, and you shouldn’t rush into paying it off straight away.
Normally, you would settle your loan by paying 9% of any salary above £26,575, starting from the April after you graduate. Anything outstanding 30 years after this is written off. The Institute for Fiscal Studies estimates that three quarters of graduates in England will never repay their loan in full before this happens – not helped by the punitive interest that begins to accumulate while you study. Even without this interest, the majority will probably never even repay what they borrowed. It’s worth considering whether to use some of your inheritance to settle a student loan only if there’s a good chance that following the repayment schedule leaves you repaying more than you borrowed.
Once your debts are settled (bar student loans), set aside six months’ worth of living expenses. This is your safety net against the eventuality of something going wrong. If you’re made redundant, for example, you might realistically find another job in six months. If you can’t work because of serious illness, you may need emergency funds to cover medical care alongside living costs. Some businesses have an income protection policy in place, which means you could still receive some or all of your salary while unable to work due to serious illness, but it can be some time before this takes effect.
You should calculate your buffer based on realistic expenditure rather than the cost of bare necessities. The goal is to give you the option of maintaining your current standard of living during a time when you can’t work. The last thing you need during a situation that may already be quite stressful is the added strain of figuring out whether you have to cancel Netflix or turn off the heating. If you take into account necessities (rent, bills, food) and non-essentials (new clothes, evenings out, streaming subscriptions) and put aside six months’ worth of cash, you won’t have to adjust your expenditure too drastically should disaster strike.
For the self-employed, it is wise to put aside a 12-month buffer instead, to be on the safe side. Without an employer you’re unlikely to receive employee benefits or the equivalent if you’re no longer able to work.
Step 2 – Owning your home
Renting has its benefits – you can leave with short notice, you aren’t generally responsible for maintenance, and your flatmate might do all the cooking. But owning your home offers an extra level of security. It could also reduce your expenditure in retirement, as you would hope to have paid off your mortgage by then. If there are periods when money is short, you can always take on a lodger (and hope they happen to be a Michelin-starred chef).
Whether you buy outright, take out a mortgage or decide to defer the process for a while will depend on the size of your inheritance or gift, your income and your personal goals, among other things. There’s something to be said for holding off for a few years if your current salary would only allow you to buy a one-bed flat somewhere you can’t see yourself staying for very long. You should also bear in mind that if you intend to use an Individual Savings Account (ISA) product that comes with a government bonus, like a Help to Buy or a Lifetime ISA (LISA), this is applicable only to your first home, so it’s worth waiting to use it on a house you want rather than one you can afford now.
Below are some examples of different options you might consider, based on the value of your inheritance.
£5,000
This could make up a chunk of a substantial deposit. However, with house prices as they stand, £5,000 won’t get you very far. You’ll most likely want to grow it through investment for a few years. Consider saving through a LISA. Review your income and expenses and decide how much you could realistically put away each month/year towards the deposit and continue to add to the pot.
£50,000
If you want to buy immediately, this could provide you with a significant deposit. Try out a couple of online calculators to see what mortgage you might get on your current salary and to find out what your house price budget is. If you’re at the start of your career, you can expect your salary to rise within the first few years. With that in mind, you should consider taking out a mortgage that tightens your budget to begin with but allows you to buy a three-bed semi rather than spending less on a flat that suits your current lifestyle.
You might decide that you still can’t afford the mortgage on your ideal home yet, in which case you could hold off buying and invest the money. In a few years, when you’re earning an income that can support the mortgage on a house you want, the money will hopefully have grown. Similarly to the example above, consider the different ISA products and how they could suit your needs.
£500,000
Depending on the value of your desired property, you might be able to buy outright straight away. However, you might consider taking out a mortgage even if you could buy without one. There may be more valuable ways to use a portion of the money – investing more into your pension to give it longer to benefit from compounding, for example, or paying off student loans (if it makes sense to do so, as discussed in Step 1). Just because you can spend all of the money on a house doesn’t necessarily mean you should[1].
Step 3 – Income to meet your needs
Your needs are undoubtedly going to change over the course of your life. Career development, family expansion, personal priorities and care responsibilities will all affect how much you require to fund your lifestyle.
If your needs are relatively inexpensive now, you might see it as a chance to save for later. Don’t underestimate how expensive life can become – e.g. many fail to realise how much the cost of raising a child can be. Even without trips to Disney World, the bare essentials can add up quickly. They can force parents back to work when they would have liked a few more months of leave. Anticipating some of these expenses could allow you more freedom when you really need it.
Savings
When it comes to savings, it is important to begin early and continually add to them. Consider savings as various pots, each with a different goal and time horizon and that will benefit from consistent watering. For example, a short-term pot might be your six-month buffer and medium-term a house. Long-term will almost always be your pension.
Pensions
A pension is another cost many fail to prepare for. A popular misconception is that you don’t need to save for retirement until you’re a few years away. Others think that the state pension will suffice. Average life expectancy is 81, and many live longer – retire at 65 and you might need to fund another 15-20 years. Fortunately, by starting young you give yourself the best chance of having sufficient income during retirement.
Firstly, maximise the free money available. When you first become employed, you’re likely to be auto-enrolled into the company pension scheme. You’ll be given the option to opt out, but in doing so you would miss out on the employer contribution to your pension.
Most companies offer a matching scheme. A percentage of your salary is automatically paid into your pension every month, and your employer also contributes to it. Currently, the minimum amount set by the Pensions Regulator is 5% from the employee and 3% from the employer. So of the 8% total contribution you pay only 5%. Some companies will also offer this on a scale – if you increase your contribution percentage, they may as well. For example, if you doubled your contribution to 10%, they may double theirs to 6%. On top of that, you receive a government contribution in the form of tax relief. A 5% contribution is usually so small that you won’t notice its absence each month. You are certain to notice the impact in 30 years. This 5% ‘waters’ your pension pot in small but consistent drips, allowing it to grow quietly and benefit from compounding.
You may also consider building up a private pension alongside your workplace pension. In the tax year 2021-22 you’ll receive tax relief on contributions to your pension of up to 100% of your earnings or £40,000 – whichever is lower. If you are approaching retirement, have a six-figure or seven-figure income and have never paid into a formal pension, then at this point you don’t have the option to make large pension contributions without incurring substantial tax charges – which is another reason to start saving as soon as possible.
Conclusion
The conversation around money is often serious, but don’t forget to have fun! This guide should help you take care of the serious side. Enjoy a holiday or evening out in the knowledge that all your short-term and long-term financial needs are accounted for! Ultimately, your loved ones want you to be happy. Money isn’t the source of happiness, but it can definitely help.
Phoebe’s story
At 21, it seemed premature to think about receiving a substantial financial gift. Any inheritance from my grandparents would be shared between my extensive extended family. In addition, my parents have only just stopped paying school fees. They aren’t about to give me more than the occasional train fare home.
Then I was asked what might happen if they died suddenly. I find it morbid to think about, but realised I wouldn’t know what to do with an inheritance I received. This led to a conversation that too few young people have with their parents.
I asked them what they would want me to know before inheriting. They each took a different approach.
Dad’s list was practical and investment-focused:
- Invest the money – don’t leave it in a bank to depreciate in value through inflation.
- But don’t rush investment decisions. Seek advice and plan your long-term goals – do you want capital growth, income generation or a mix?
- Keep some liquidity in case of unforeseen events.
- Stay informed about the economy and its cycles.
- Diversify – make sure you hold a range of assets that won’t all be negatively affected by the same market conditions. This helps to mitigate some of the risk that comes with investing.
- Ideally, invest across a range of assets. Aim for an element of capital preservation, an income (e.g. dividends) and the potential for capital growth.
- Look outside the stock market for investment opportunities. You could invest in property, gold, or other assets (e.g. wine).
- Avoid following the crowd – herd instinct will lead to overpaying.
- Don’t be greedy – you can’t expect to call the top of the market on a share. Watch the prices and sell some of the shares when you feel you’ve made a decent gain. Remember that you don’t have to sell them all.
- Make sure you’re investing in a tax-efficient manner, potentially through a pension scheme or ISA product.
Mum’s was more emotional but still wise:
- Earning money and receiving money as a gift are two different feelings. An inheritance is the product of hard work and shouldn’t be wasted…
- …but it is a gift, so do with it what you want. A good question to ask is: would the person giving me the gift be happy if they saw how I was using it?
- Giving money to charity is tax-free and allows you to do good for your fellow human.
- Money isn’t the source of happiness, but it’s a useful tool. Being broke and unable to pay the bills can be extremely destructive to your own wellbeing and your relationships. Split the money between necessities, luxuries, and savings.
- Keep an escape pot in case of emergency.
- Making no decision can be worse than making a bad decision – don’t procrastinate.
- Don’t loan to friends or family unless you can treat it as a gift.
- Make a habit of putting money away as soon as you get it. That way, you’re not tempted to spend more than you can afford to.
- Invest when you’re young to increase your freedom when you’re older.
- A home is a home. While property is technically an investment, trying to make money out of your house can be stressful. Avoid debt that overstretches you. Focus on making your home one that you love, feel safe in and can afford.
There are similarities in their responses – both stress the importance of thinking about the future. Saving is arguably the least exciting thing you could do with a financial gift. But, as Mum says, investing when you’re young could increase your freedom when you’re older. It was reassuring to have this conversation. Beforehand I would have been anxious about wasting an inheritance and probably would have let it sit in a bank for too long. Now I’m confident that I would be able to make the most of it. I think I could use it in a way that would make my parents (and myself) happy.
[1] If you’re expecting a large inheritance and are saving as well, with a view to buying an expensive first home, be aware that the LISA scheme may not be appropriate, as the home must cost less than £450,000. Tying your money up in a LISA could mean you incurring heavy penalties or having to lower your budget.
