I Inherited Money—What Should I Do With It?

Inheriting money can significantly shift one’s financial landscape, often bringing a mix of emotions and practical considerations. This financial influx necessitates careful thought and planning for effective management. Understanding initial steps, tax implications, and future uses is foundational. A clear strategy ensures these funds align with your long-term financial well-being.

Initial Actions and Understanding the Estate

Upon learning of an inheritance, prioritize locating essential documents and understanding the deceased’s estate. Identifying the will or trust documents is a primary step, as these outline asset distribution. If a will exists, it typically names an executor who manages the estate. If a trust is involved, a trustee manages its assets for beneficiaries.

Establish communication with the executor or trustee to understand the process and timeline. Asset transfer can occur through mechanisms like probate, the court-supervised process for validating a will and distributing assets. Assets in a trust, those with designated beneficiaries (like life insurance or retirement accounts), or jointly owned property with rights of survivorship generally bypass probate.

Categorize the types of assets received, such as cash, real estate, investment accounts, retirement accounts, life insurance proceeds, and tangible personal property. Each asset type may have distinct transfer procedures and implications. For instance, bank accounts may transfer via “payable on death” (POD) designation, while investment accounts might use “transfer on death” (TOD).

Accurate valuation of inherited property is important, as this value often establishes a new cost basis for tax purposes. Seeking guidance from an attorney or financial advisor is highly recommended during these initial stages to navigate legal complexities and ensure proper handling.

Taxation of Inherited Assets

Understanding the tax implications of an inheritance is a central concern, as various types of assets are treated differently by tax authorities. Two main types of taxes may apply: estate tax and inheritance tax. Federal estate tax is levied on the deceased person’s estate before distribution; for 2025, estates valued below $13.99 million are generally exempt. Some states also impose their own estate taxes, with varying exemption thresholds.

Inheritance tax, in contrast, is paid by the beneficiary, not the estate. This tax is imposed by a limited number of states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Rates and exemptions often depend on the beneficiary’s relationship to the deceased, with spouses typically exempt. Maryland uniquely imposes both an estate tax and an inheritance tax.

Income tax implications vary significantly by asset type. Inherited retirement accounts, such as IRAs and 401(k)s, generally do not receive a “step-up in basis” and are subject to income tax upon withdrawal. For non-spouse beneficiaries, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 often requires distribution within 10 years. Spousal beneficiaries typically have more flexible options, including rolling the inherited IRA into their own.

Appreciated assets like stocks or real estate benefit from a “step-up in basis” to their fair market value on the date of the original owner’s death. This adjustment can significantly reduce or eliminate capital gains tax if the asset is sold shortly after inheritance, as the taxable gain is calculated from this new, higher value.

Life insurance proceeds paid directly to a beneficiary are generally not taxable income for federal purposes. However, any interest earned on the proceeds while held by the insurance company may be taxable. Future income generated by inherited assets, such as rental income from property or dividends from investment portfolios, is typically taxable to the beneficiary. Receiving relevant tax forms, such as Form 1099-R for retirement account distributions or K-1 for partnership income, is important for accurate tax reporting.

Options for Inherited Funds and Property

Once inherited funds and property are received and their tax implications understood, a range of options becomes available. One immediate use is debt repayment, particularly high-interest debts like credit card balances or personal loans. Eliminating these debts frees up significant monthly cash flow and reduces financial strain.

Establishing an emergency fund is another prudent step. Aim for three to six months of living expenses in savings to cover unexpected costs like job loss, medical emergencies, or home repairs. This financial safety net prevents incurring new debt or liquidating long-term investments during difficult times.

For those with adequate emergency savings and minimal high-interest debt, investing the inheritance for long-term growth is a common strategy. This can involve contributing to traditional investment accounts, exploring real estate opportunities, or funding a new business venture. Various options exist to align with different financial goals and risk tolerances.

Inherited funds can also facilitate significant life purchases. A substantial inheritance might serve as a down payment on a home, potentially reducing mortgage costs or allowing for quicker homeownership. Funds could also be allocated towards educational expenses for oneself or family members, or used to invest in a business.

Charitable giving is another meaningful way to utilize a portion of an inheritance. Donating to a chosen cause provides personal satisfaction and may offer tax benefits. Beyond immediate uses, an inheritance can create a lasting legacy. Establishing a trust can help preserve wealth across multiple generations, provide ongoing financial support, and potentially minimize future tax burdens.