An inheritance can provide a big financial boost. Through investment, those receiving inheritances can really increase their savings. But according to a recent study, half of inherited wealth will be spent, lost or donated. That's good news for retailers, but it is bad news for the U.S. savings rate. Families and individuals who spend that money can get stuck without an economic safety net. People who experience job loss, pay cuts or illness and who lack a safety net often are late paying bills, slash their spending, and sometimes go bankrupt, all of which impact the economy. So, should you save it or spend it?
We spoke with Jay Zagorsky, research scientist at The Ohio State University’s Center for Human Resource Research, about his recent study and its implications. Zagorsky's research study is titled, "Do People Save or Spend Their Inheritances? Understanding What Happens to Inherited Wealth."
Why is the issue of how people use their inheritances important economically?
How people spend or save their inheritance is important because numerous surveys show many people in the U.S. have relatively little or no savings. Savings provides a financial safety net for when you unexpectedly lose a job, have a health problem or incur a large expense. People who do not have a financial safety net often end up in bankruptcy or foreclosure when unexpected problems arise. If people cannot build up savings by spending less than they earn, then it is important for people to save some of the money they receive as inheritances and gifts.
How are financial markets affected if recipients of an inheritance spend most of what they inherit?
Prices in financial markets fall when large numbers of recipients sell most of the stocks and bonds they inherit. When people spend the money they get from selling these stocks and bonds, there is less money being invested in the country. When less money is available for investment, there is decreased financial support for new companies, inventions and jobs, which reduces economic growth.
Assuming the estate tax law is revisited and the policies are changed to boost savings of inherited wealth, do you believe this will change the behavior of adults who receive an inheritance to save more of their inherited wealth?
I am optimistic that improved government policies can boost savings of inherited wealth. Even if policies are not changed, simply telling people that the average inheritor spends about half their inheritance can have an impact. By knowing this fact, inheritors can prepare themselves in advance and restrain themselves from spending that much.
Could you elaborate on your proposal to change the tax code for long-term savings accounts, such as IRAs, as another incentive to encourage individuals to save their inheritance?
One way to boost savings from inheritances is to allow inherited money to be channeled directly into IRAs, which is not currently possible. IRAs boost long-term savings because the early withdrawal penalties stop most people from raiding their accounts before retirement. Currently, yearly contributions must come from earned income and are capped for people younger than 50 at $5,000 per year.
My suggestion is to change the rules in two ways. First, the requirement that contributions come from earned income should be waived, so the money can come from inherited funds. Second, people using inherited funds should have higher contribution caps. Making these changes will solve two problems: It will boost savings, and it will remove the temptation for people to spend their inheritance.
According to your study, recipients of an inheritance only spend half of their wealth. What are the pros and cons of this finding?
Since the money does not disappear from the economy, this is positive news for retailers, restaurant owners, remodelers and people in the service industry who will see increased sales. The spending is bad news for bankers, stockbrokers and financial planners who will have fewer assets to manage. It is also bad news for all people concerned about low U.S. savings rates and the financial destitution of many families.
We would like to thank Jay Zagorsky, research scientist at The Ohio State University’s Center for Human Resource Research, for his insight on this topic.