What Is the Best Thing to Do With an Inheritance?

Receiving an inheritance is a significant life event, offering an opportunity to enhance one’s financial well-being. Making informed decisions about these funds is important for securing long-term stability and achieving financial aspirations. This article provides a structured approach to understanding and utilizing an inheritance effectively.

Understanding Your Financial Landscape

Before making decisions about an inherited sum, gain a clear understanding of your current financial situation. This comprehensive assessment serves as the foundation for strategic planning, helping identify areas where the inheritance can provide the most benefit.

Review existing debts, especially those with high interest rates like credit card balances or personal loans, which often carry high annual percentage rates (APRs). Understanding the total balances and specific interest rates for each debt allows for a targeted approach to repayment.

Evaluate your emergency savings fund. Financial professionals recommend setting aside three to six months of essential living expenses. This fund acts as a financial buffer against unexpected events like job loss or medical emergencies. Assessing your current coverage helps determine if bolstering this safety net is a priority.

Review existing savings and investment portfolios, including traditional savings accounts, retirement accounts like 401(k)s and Individual Retirement Accounts (IRAs), and other investment vehicles. Understanding your current asset allocation provides a complete financial picture. Reflect on your short-term and long-term financial goals, such as homeownership or retirement, to establish how the inheritance might help achieve these objectives.

Prioritizing Financial Goals

Once your financial landscape is clear, strategically allocate your inheritance to align with your financial goals. A common hierarchy can guide decision-making to maximize the long-term impact of these funds.

Addressing high-interest debt is a primary consideration. Paying off obligations like credit card debt or personal loans, which can have high interest rates, eliminates costly interest payments. This reduction in financial drain can free up cash flow for future savings and investments. Eliminating these debts improves overall financial health.

Augmenting an insufficient emergency fund is another priority. If current savings do not cover three to six months of essential living expenses, use a portion of the inheritance to reach this target. A robust emergency fund helps prevent future debt accumulation when unexpected costs arise. This financial cushion offers peace of mind.

For long-term financial growth, maximize contributions to tax-advantaged retirement accounts. Traditional IRAs and 401(k)s allow for tax-deferred growth, while Roth IRAs and Roth 401(k)s offer tax-free withdrawals in retirement. These accounts offer benefits due to compounding, where investment earnings generate returns over many years. Utilizing these vehicles can boost retirement savings.

Beyond retirement accounts, general investment accounts can be used for other long-term goals or for funds exceeding retirement contribution limits. Diversifying investments across various asset classes can help grow wealth over time, though these accounts do not offer the same tax advantages as dedicated retirement plans. For educational aspirations, contributing to education savings plans, such as 529 plans, can be beneficial. These state-sponsored plans offer tax-free growth and withdrawals for qualified educational expenses, including tuition for K-12 schools and higher education.

A portion of the inheritance might be allocated towards planned expenditures that align with personal goals, such as a down payment on a home or starting a business. These investments can improve quality of life or generate future income. For those whose financial needs are well-covered, considering charitable contributions or gifts to family members can also be a meaningful use of inherited wealth.

Navigating Tax Implications

Understanding the tax implications of an inheritance is important, as misconceptions can lead to unexpected financial obligations. The rules differ from those applied to earned income. Clarifying these distinctions helps manage expectations and plan effectively.

Receiving an inheritance is not subject to federal income tax for the beneficiary in the United States. If you inherit cash, real estate, or investments, you do not owe federal income tax for receiving these assets. Exceptions exist, such as income the deceased was entitled to but had not yet received.

Federal estate tax is levied on the deceased person’s estate, not on the beneficiary. This tax only applies to large estates, with exemption thresholds set at high amounts. For instance, in 2025, the federal estate tax exemption is $13.99 million per individual. Most estates are not subject to federal estate tax.

While federal inheritance tax does not exist, a few states levy an inheritance tax directly on the beneficiary. As of 2025, states such as Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have an inheritance tax. Rates and exemptions vary based on the relationship between the deceased and the beneficiary.

Any income generated from inherited assets after you receive them is taxable income. For example, dividends earned from inherited stocks, interest from inherited bank accounts, or rental income from inherited property are taxable.

Capital gains tax can apply if you sell an inherited asset that has appreciated in value since the date of the original owner’s death. Inherited assets often benefit from a “step-up in basis” rule. This rule resets the asset’s cost basis to its fair market value on the date of the previous owner’s death. This adjustment can reduce or eliminate capital gains tax if the asset is sold shortly after inheritance, as capital gains are only calculated on appreciation after the date of death.

Seeking Professional Financial Advice

Navigating the complexities of an inheritance can be complex, and seeking professional financial advice is prudent. Expert guidance can provide clarity and help optimize decisions regarding wealth management, investment strategies, and tax planning. A financial professional offers an objective perspective tailored to your circumstances.

A financial advisor or planner can assist in creating a comprehensive financial plan, integrating the inheritance into your overall financial picture. They can help set goals, develop investment strategies, and guide financial decisions. When choosing an advisor, consider seeking a fiduciary, who is legally obligated to act in your best interest.

A tax professional, such as a Certified Public Accountant (CPA), can provide specific tax guidance related to the inheritance. They can clarify complex tax rules, help with reporting requirements, and offer insights into minimizing tax liabilities. This expertise ensures compliance and can identify tax-saving opportunities.

An estate attorney may be beneficial, especially if the inheritance involves complex estate issues or if you are updating your own estate plan. They can provide legal advice on probate, trusts, and other legal aspects of inherited assets. For comprehensive financial planning, the Certified Financial Planner (CFP) designation indicates an advisor has met rigorous education, examination, experience, and ethical standards. These professionals are held to a fiduciary standard, prioritizing client needs.