Receiving an inheritance is a significant life event, often accompanied by complex emotions. While it can provide a substantial financial boost, the responsibility of managing it wisely can feel overwhelming. The most common instinct is often to eliminate debt, particularly the mortgage on the family home. While this provides an immediate sense of security, it may not be the most strategic move for maximizing your wealth over the long term.
This article explores how to best utilize an inheritance, moving beyond the default option of debt repayment. We’ll consider powerful alternatives like strategic investing and superannuation contributions—approaches that can unlock far greater long-term financial benefits by leveraging compounding growth and the unique tax advantages of super. Understanding these options will help you make choices that align with your personal goals and secure your financial future.
The Debt Repayment Dilemma: Security vs. Opportunity Cost
Paying off your mortgage or other debts offers a guaranteed, risk-free return—if your home loan interest rate is 6%, clearing that debt equals a 6% after-tax return. This can offer immediate peace of mind and a simpler financial life.
However, using your inheritance solely to clear debt may mean missing out on wealth-building opportunities. Once your inheritance is locked up in your home, it’s no longer available to invest for growth. Over decades, a diversified investment portfolio or super contributions can potentially deliver higher returns, especially given the power of compounding. Even a small annual difference in returns can dramatically increase your net worth over 10, 20, or 30 years.
Imagine you inherit $500,000 with a $500,000 mortgage at a 6% rate.
- Option 1: Pay Off the Mortgage. You guarantee $30,000 a year in interest savings, but your $500,000 becomes illiquid.
- Option 2: Invest the Inheritance. If a diversified investment portfolio averages an 8% annual return, your first year’s growth is $40,000. After covering $30,000 in mortgage interest, you’re $10,000 ahead—and your capital remains invested, compounding year after year.
Over the long term, the compounding effect means the invested inheritance could grow exponentially, far outpacing the interest saved on your mortgage. This can add up to hundreds of thousands, or even millions, in additional wealth depending on returns and timeframes.
Strategic Investing: Building Lasting Wealth
Instead of using your inheritance to eliminate “good debt” like a mortgage, you may choose to invest it for long-term financial growth. A well-structured investment portfolio spreads your risk and targets higher long-term returns, building wealth that can fund your retirement, support your family, or leave a legacy.
The real benefit comes from compounding—when your investment returns themselves begin to earn further returns. The longer your money is invested, the larger the potential snowball effect, helping your inheritance multiply many times over.
By working with a financial adviser, you can build a diversified portfolio tailored to your goals, risk tolerance, and time horizon. This approach aims not just for immediate gains, but for sustainable wealth decades into the future.
Superannuation: Supercharge Your Future
For many Australians, boosting your superannuation with part of your inheritance is one of the best moves for long-term wealth creation—thanks to the tax savings and the compounding growth available in super.
Making the Most of Super Contributions
There are two main ways to increase your super balance with an inheritance:
- Concessional (Before-Tax) Contributions: The current annual cap is $30,000, and if you haven’t fully used this cap in the past five years, you may be able to make extra contributions (known as “carry-forward” contributions). These can reduce your taxable income and help your super grow faster.
- Non-Concessional (After-Tax) Contributions: You can contribute up to $110,000 per year from after-tax funds, or bring forward up to $330,000 over three years.
Adding more to your super not only boosts your retirement savings, but also moves your investments into a tax-advantaged environment. Once you retire and move your super into a pension account, investment earnings and withdrawals are generally tax-free if you’re over age 60.
Compounding and Tax-Free Growth
Maximizing super contributions means more of your money compounds over decades in an environment with little or no tax on returns. For example, contributing $330,000 from your inheritance could, with average market growth, potentially double or triple in value over a typical retirement planning horizon. The advantages are even greater thanks to the 0% tax in pension phase, allowing your retirement income to go further and last longer.
A Balanced, Long-Term Approach
The best solution might be a blend of strategies. You don’t need to devote your entire inheritance to one goal. Many people choose to:
- Pay down some mortgage: Reduce monthly repayments and ease financial pressure.
- Make super contributions: Grow tax-effective retirement wealth for the long term.
- Invest the remainder: Build a diversified portfolio to take advantage of compounding returns.
This balanced approach can give you both the immediate benefits of debt reduction and the powerful, longer-term growth from investing and super contributions.
Charting Your Course for Decades Ahead
An inheritance is a unique opportunity to shape your financial future. While paying off debt is tempting, analyzing the longer-term benefits of investing and building your super can help your wealth grow for decades—and provide greater financial freedom for you and your family.
Ultimately, the best use of an inheritance will reflect your goals, risk tolerance, and timeframes. If you’re unsure, a qualified financial adviser can work with you to design a plan that lets your inheritance become a springboard for lasting prosperity.