There’s been a lot of discussion centered around this topic as of late and I figured I’d weigh in with my two cents, for what it’s worth.

The question is: Should you use your inheritance money to pay off debts?

It’s a tough question to be sure. On the one hand, you’ve just lost someone pretty close to you. You’re going through a period of grieving and the thought of spending their money probably makes you feel uncomfortable. On the other hand, the money may have come at a fortuitous time and could really help out with the bills. It’s a tough dilemma.

The trouble is, any decision you make at this point is based purely on emotion. It’s kind of hard to take a step back and look at the situation from an objective viewpoint, and people would probably think you were heartless if you could. But, as Frugal Dad points out, any time a decision is made based on emotion there is a greater chance of making a big mistake.

So, here’s my thought process when it comes to making a decision about using inheritance money or not.

# 1 – List your goals

If you haven’t done so already, now’s the time to list your goals and prioritize them. This will give you a visual of what you want to accomplish and may even help you identify which route is the best for you and the inheritance money.

# 2 – Make sure you have an emergency fund

I talk about emergency funds a lot, and I know the Ramsey followers probably think the $1000 is enough and that the next step is to knock out the debts. However, given the state of the economy where everything is sort of up in the air, I think it’s a better idea to have at least six months worth of expenses saved. You won’t be making any payments on anything if you don’t have an income. So, it’s best to protect yourself for the worse-case scenario first. It’s the equivalent of having insurance…it’s there just in case.

# 3 – Look at retirement

I’ve mentioned before that I don’t think retirement should take a back seat to debt, particularly because you can’t make up the years you miss. Compound interest is a wonderful thing, but it can also work against you. So, if you’ve been neglecting your retirement accounts, now’s the time to consider them. Obviously people’s 401(k)s have lost money, so sticking funds into similar products within an IRA may not be appealing. However, IRAs house more than mutual funds and stocks. You can choose safer investment vehicles if that is your wish. But, if you’ve got a bit of money to put towards your retirement goals, then I recommend getting with a financial advisor and talking it out. At the very least, take a look at your options. But, I don’t recommend that you keep neglecting your retirement. Remember, pay yourself first!

# 4 – Consider your debts

Once your emergency fund and retirement accounts are taken care of, then you should consider paying off debts. You may not have a large inheritance, in which case you’ll want to prioritize your debts and see which ones would be the most beneficial to pay off. But here’s the thing. If you haven’t made a conscious lifestyle change, meaning you haven’t committed yourself to living debt free and working towards that end, having your debts paid off will do you little good. It’s like the lottery winners who go bankrupt. Nothing changed for them except the amount of money they had to spend. The point is, if you’re just going to run your credit cards right back up, there’s probably not much sense in paying them off. You’d be better off just saving the money.

But, if you’re committed to a frugal lifestyle and you’re working your way out of debt, then paying off your debts with the remainder of your inheritance money may make the most sense financially. In which case, pay them off if you can. I say ‘if you can’ because for some, this decision will always be an emotional one. Someone may feel they can’t use the money to pay off debts because the decedent would disapprove. Another person may feel that the money is all they have left of the decedent and so they’ll keep it as a means of hanging on to their loved one.

In the case of worrying that a loved one will be disappointed in how you spend your inheritance, keep in mind that they have the right to specify how the money can be spent. If they didn’t want you to spend the money on debt, they would have said so in their will. Most loved ones leave an inheritance behind so that their kids and grand kids are well taken care of, no matter what that means.

In the case of sentimentality, only you can decide what’s best for you there. I see the view point. When my grandmother died, she left me a small trinket that I cherish dearly because it is all that I have left of her. I still have it and couldn’t possibly imagine parting with it. For me, I had a physical object. Money is a little different, but it’s the same concept. I would say that in the instance money is left behind, the intent is that it is used to better your life – even if that means paying off your debts.

At the end of the day, if you’re still too emotional to make a decision, I recommend parking it in a high yield savings account  or CD until you’ve had time to process everything and think things through. There’s no rush, so take your time and decide carefully.

What are your thoughts on the matter? Do you automatically pay off the debts, or would you have some reservations about spending the money?

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