3 Smart Ways to Spend Your Inheritance

The Deceased Laying In A Coffin At His Funeral With Bags Of Money Surrounding Him
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Great news! According to a recent survey from Bankrate.com (RATE) subsidiary Interest.com, there's a good chance that you will soon inherit a share of a vast sum of money.

A recent poll taken by the financial gurus at Interest.com shows that barely a quarter of Americans expect to receive an inheritance in their lifetimes. And yet fully 64 percent of American retirees say that as a matter of fact, yes, they do have some money lying around -- $6 trillion in total, give or take. And they do plan to leave some of it to the younger generations in their wills.

And that's where the trouble begins.

Bad News! There's a Good Chance You'll Soon Inherit Some Money

For most of us, the prospect of getting a windfall inheritance from Grandma, Granddad, Mom, or Pop will be bittersweet at best. On one hand, there's the passing of a loved one. Of course, on the other hand, there's a pile of dough to cushion the blow.

On the third hand, though, that money may not last very long.

As Michael Finke, a personal finance professor at Texas Tech University in Lubbock, told Interest.com, people who receive a small inheritance tend to spend the money rather quickly: "When you receive an inheritance that's under $10,000, you tend to frame that as spending money."

%VIRTUAL-article-sponsoredlinks%Fellow Texas Tech professor Russell James notes that even when larger amounts are inherited, "at least half the people are just going to blow it. And by blow it, I mean 12 months later it's gone."

What do they spend the money on? Interest.com's survey finds many respondents surprisingly candid about how they'd spend a windfall. Nine percent would use the cash to buy a bigger house. Three percent would blow it on jewelry or a nice car. And 3 percent would take a vacation.

The Road That's Paved With Good Intentions

These aren't the best choices, of course. And most people say they plan to take better care of any money they should inherit.

Certified financial planner Erin Baehr of Baehr Family Financial in Pennsylvania points out to Interest.com that among her clients who expect to inherit money, the three uses for the inheritance most often mentioned are to "pay off their mortgage, pay for their retirement and pay for their kids to go to college."

Interest.com's survey found these same choices to be the most popular options nationally, with about 72 percent of respondents saying they'd either save an inheritance windfall, use it to pay down debt, or spend it on education.

The Big Three

Compared to blowing an inheritance on jewelry, McMansions, and Hawaiian vacations, there's no question: Saving, paying down debt, and getting an education are better ways to use an inheritance.
They also tend to echo the advice of many financial planners, whose road map to financial security generally runs in three major phases:

First,set aside a rainy-day fund. Six to 12 months' wages is the usual benchmark to ensure you're sufficiently "liquid" to withstand short-term financial turmoil, and won't be pressed to find cash to deal with any of life's little surprises.

Second, once that rainy-day fund is established, pay down high-interest debt (credit cards, car loans) first, then move on to lower-interest debts (student loans, home mortgages). Savings need to come before debt paydown because you don't want to get stuck in a situation where you've paid off your debts, then get surprised by a big bill when you have no cash to pay it, and wind up having to go right back into debt.

Third, once you're debt-free and have your rainy-day fund established, any "extra" cash left over can be invested for the future. Ordinarily, this advice refers to investing in stocks, bonds, and mutual funds. But given that unemployment rates for college graduates these days are just half the rate of unemployment for high school graduates, "investing" in your kids' education seems a perfectly valid corollary -- and one that could pay dividends in the form of bigger paychecks.

As a matter of fact, with the stock market as richly valued as it is these days, using an inheritance to help Junior achieve a college degree and the higher earnings potential that goes with it just might help secure your retirement as well.

Motley Fool contributor Rich Smith has no position in any stocks mentioned.