The other day I was listening to a local radio show about personal finances. The host took a call from an emotional listener (I’ll call her Kelly) who had recently lost her mother to cancer. Kelly’s mother left behind a $100,000 life insurance policy, along with a number of other assets to be split between Kelly and her sister.
Over the last year or so Kelly and her husband have been getting their financial lives back on track. They had whittled their outstanding debts down to about $30,000 (from $50,000), spread evenly across a couple credit cards, an old student loan, and a car note. It turns out their portion of the inheritance was just enough to pay off all the family’s debt plus $20,000. Kelly felt conflicted about paying off debt with her inheritance money.
The show’s host seemed equally conflicted, even though the answer was obvious to me. Yes, the caller should use the money to be debt free by the end of the day. How did I arrive at this answer so quickly? A number of factors were at play.
Three Questions To Ask When Deciding To Use Inheritance To Pay Off Debt
1. Will I need to live on this money in the near future? This might be the case for a spouse who wasn’t working prior to their spouses death, or in the case of two retirees living off of the now deceased’s salary. In Kelly’s case, her husband earns a good income, and they had some emergency savings already in place. It wasn’t likely they would need to live on any of this inheritance.
2. Has my lifestyle changed? Consider whether or not the lifestyle that led you to debt has changed. If you are still overspending, using credit cards, and financing emergencies, then chances are you will go right back to that behavior after your debts are paid. This is the very reason most lottery winners grow broke – their lifestyles never change, just the amount of money they have to blow.
3. If you had the same amount of inheritance already in savings, would you go into debt to avoid spending it? This is really the same question in reverse. Not using inheritance money to pay off debt is the equivalent of leaving money in savings while financing something(s) of equal value. The only time this might make any sense is when financing a home at a very low interest rate, but even then, a free-and-clear home looks pretty attractive, too.
An Emotional Decision
Deciding whether or not to use an inheritance to pay off debt is a very emotional decision. Any time you mix emotions with money you have the opportunity to make a very big mistake. But after losing a loved one it is hard to remain objective, and the tug of our emotions often leads to irrational decisions.
If you find yourself in this position, and aren’t sure what to do with the money, simply park it in a bank savings account for a couple months while you allow your emotions to heal. After that “cooling off” period you can again evaluate your financial picture and make a smart decision about how to handle the money.
Part of what bothered Kelly about using her mother’s inheritance money to pay off debt was a feeling that her mom would somehow disapprove, or be upset to know Kelly owed that much money. As a parent, I would want my kids to do what’s best for their family, and if being debt free was a goal for them, and it freed them from the bondage of being indebted to banks, then I would be happy to know that’s how they used the money. I suspect most parents would feel exactly the same way.