Special Feature: Major Moments Full coverage From debtors to millionaires overnight A surprise inheritance will secure this family's future -- once they figure out what to do with it. By Cybele Weisser, MONEY Magazine Planning your nest egg • • • John and Erin borrowed heavily to buy their million-dollar-plus Santa Barbara home last year. NEW YORK (MONEY Magazine) - A year ago, a series of phone calls turned John Baran's life upside down. The first came as he sat in a classroom in Ithaca, N.Y., 3,000 miles away from his wife and kids. His stepmother was calling to tell him that his 63-year-old father had died suddenly. Then, weeks after Baran returned to school from his home in Santa Barbara, he had more unexpected news: a call informing him that he was the sole heir to his father's half-million-dollar 401(k). Stunned and upset, he barely registered a single detail from the conversation and had to call back to check the amount. "It didn't sink in," recalls Baran, 37. "I had no idea he'd saved that much." After all, Baran hadn't grown up rich. His father worked as a meter reader for an electric company for 35 years and raised his family in a modest 1,900-square-foot three-bedroom home near the University of California at Santa Cruz. But an even bigger surprise was still to come. About a week later, his stepmother e-mailed to say that he'd also inherited his childhood home, now worth $850,000, with just $148,000 left on the mortgage. Over the phone, his wife, Erin Chrislock, read him the will that had just arrived in the mail. "It was very emotional," says Baran. "I had an immediate feeling of sadness, but I also felt some relief as far as our monetary situation." Though Baran and Chrislock's financial state was hardly dire, it was, they admit, precarious. Baran has been a full-time student for the past two years, working toward a master's degree in landscape architecture, while Chrislock, a 32-year-old lawyer, has been supporting the family, which includes kids Austin, 9, and Kylie, 2. She makes good money -- $165,000 a year -- but still, the couple have relied heavily on debt to get established. They'll owe $100,000 in student loans by the time Baran earns his degree next spring. They bought a home in Santa Barbara last year for just over $1 million, borrowing $170,000 from her mother for the down payment and financing the house with an interest-only loan that has a fixed rate for five years. Housing costs, a car lease, child care and household expenses eat up most of their cash every month. Chrislock maxes out her 401(k), but they have just $30,000 set aside for retirement, as well as a $20,000 custodial account for Austin -- and no emergency savings account. "John and Erin were kind of cruising for trouble -- they were highly leveraged with no liquidity whatsoever," says Newport Beach, Calif. financial planner Mark Rylance. Inheriting more than a million dollars will change their lives -- and keep them out of the trouble they were unknowingly flirting with -- but it will also mean some hard decisions. Suddenly secure A million-dollar windfall may sound like something out of the movies. But, in fact, as wealthy boomers die over the next 50 years, it will become almost routine. Over that time, a mind-boggling amount of wealth -- estimates start at $41 trillion -- will pass between generations, according to Boston College researchers Paul Schervish and John Havens. Much of that wealth will be in the form of real estate, leaving heirs with tough financial choices -- why sell when real estate is so hot? -- and sometimes even tougher emotional ones. Can you sell a house that's steeped in family memories? Even though he grew up in the house in Santa Cruz, Baran was initially in favor of selling it, mainly because it's a four-hour drive from their home. But renting looks like a no-lose proposition. The mortgage is just $910 a month and property taxes a mere $71. (In California, those taxes don't go up on an inherited house.) Chrislock, burned by heavy stock losses a few years ago, considers real estate a more secure investment. Plus, the rental income would relieve some of the pressure she feels as the breadwinner. "Keeping the house is appealing because it means something other than me is bringing in money regularly," she says. Baran is now undecided. "I've really been waffling," he says. Unfortunately, his father's 401(k) wasn't quite the windfall it seemed. As a non-spousal beneficiary, Baran must take the money as a lump sum, which will generate an estimated $230,000 tax bill. Still, it's enough to get a firm foothold on the future. They've already decided to spend $40,000 on a new car, which will let them drop their $500-a-month lease payments. For the rest, the couple have discussed saving money for the kids' education, as well as renovating and paying off debts, including the loan from her mother. "Not that we are brand-new-Ferrari types anyway," says Chrislock. "But we want to make sure we invest the money wisely and not spend it on frivolous things." The advice The financial planners MONEY spoke with applaud Baran and Chrislock's attitude. "This situation has given them an opportunity to really set themselves up," says planner Rylance. To that end, the couple should do the following. Sell the Santa Cruz house After adding up the costs of maintaining the house -- the mortgage, taxes and insurance, plus a property manager because the home is far away and Baran will be on the East Coast again for part of next year -- Santa Barbara planner Geoff Gaggs calculates that the couple would earn just $9,800 a year on the property, assuming no major repairs or vacancies. But what about keeping the home for the appreciation? While the California real estate market is unlikely to continue at today's red-hot pace, it has historically returned an average of 7 percent. Assuming they earn that long-term average, reinvest the rental income and owe taxes, broker fees and other costs, Gaggs figures the couple would net $1.4 million if they sold in 10 years. If they sold today, paid off the mortgage and invested $700,000 in stocks, they could wind up with about $100,000 less. But given how nervous Baran and Chrislock are about long-distance landlording, he feels they would be better off selling. Eliminate the biggest risks The family has substantial debts, but the planners agree that's okay given the low rates on their mortgage (4.25 percent) and student loans (about 3 percent). What also helps is that their income is almost certain to rise as Baran returns to work. If they decide to stay in their home indefinitely, however, they should trade their interest-only mortgage for a traditional one. What's not okay is their lack of emergency funds. "If something happened to Erin or Erin's job, they would be in serious trouble," says Rylance. The couple should keep funds to cover three to six months of living expenses in a money market fund, and get life insurance for Chrislock. Take care of college The couple want to set aside enough money to fund four years of education for both kids at a public university in California. That comes to about $100,000 in today's dollars, says Gaggs, who suggests that they invest that amount (including the money in the custodial account) in a tax-advantaged 529 college savings plan. Lock up their future What's left will go a long way toward seeding a comfortable retirement. They should invest what remains in a diversified portfolio of 80 percent stocks and 20 percent bonds; spreading their money around will help prevent big losses like the one they had a few years back. With the numbers laid out in black and white, Baran and Chrislock are feeling more sure they'll sell the Santa Cruz home. And they are basking in a newfound sense of security. "I feel that a burden has been lifted," says Chrislock. What if you inherit a house? You may see this windfall as an ideal chance to dabble in real estate investing. But is that the smartest use of a valuable asset? Consider these questions. 1. Can you handle the time commitment? Problems with plumbing, appliances and deadbeat tenants are bound to crop up. "Real estate is a full-time business," says Marty Stone, co-author of "The Unofficial Guide to Real Estate Investing." Hiring a property manager can make your life easier, but you'll sacrifice about 10 percent of the rent for the convenience of having help. 2. What kind of profit can you make? Remember: A lot more than mortgage payments and rent checks goes into the profit/loss equation. Even if you inherit a house mortgage-free, you'll face annual carrying costs. Among them: rental insurance, property taxes and maintenance, and perhaps a manager. To be safe, factor in a 5 to 10 percent vacancy rate. 3. Would you be better off selling? Yes, real estate gains have outpaced stock returns lately, but historically stocks have beaten real estate by a few percentage points. So don't assume you can rent at a loss and make it up on price appreciation. Plus, when you inherit a house, your tax basis is today's value. So selling shouldn't generate a big tax bill. Keeping a 401(k) or IRA in the family Someday you may want to pass a retirement account on to your heirs. Do it right, and your legacy won't be a nasty tax bill as well. Name an IRA beneficiary If you don't, your heirs will have to liquidate the IRA and pay income taxes on the proceeds. When you name your spouse as your beneficiary, he or she can treat the IRA as his or her own and let the money keep growing tax-free. Other beneficiaries must start withdrawing right away, at a rate based on their life expectancy. Leave it to whoever needs the money, but consider that if you give your IRA to your children, they'll be able to draw down the funds more slowly than your spouse would. Roll over a 401(k) into an IRA A surviving spouse can usually roll a 401(k) into an IRA (individual plan rules vary). Other heirs must take a lump-sum distribution and pay taxes. Leave instructions The tax rules are complicated and unforgiving if anything goes wrong. A letter in your will saying who gets the account and what to do with it can save your heirs headaches and cash.