What Is the Best Thing to Do With Inherited Money?

Receiving an inheritance marks a significant financial moment, presenting both opportunities and responsibilities. This influx of funds requires thoughtful consideration rather than immediate decisions, as its proper management can greatly influence your long-term financial well-being. This guide provides a structured approach to navigating inherited money, helping you make informed choices that align with your personal circumstances and aspirations. It emphasizes a methodical review of your financial standing and strategic planning to integrate these new assets effectively into your overall financial life.

Immediate Considerations and Financial Review

Upon receiving an inheritance, take a deliberate pause before making substantial financial moves. This initial period allows for emotional processing and a thorough assessment of your current financial landscape, ensuring decisions are based on clarity. A comprehensive review of your existing financial health is a foundational step.

Prioritize existing debt, particularly high-interest obligations like credit card debt. Using inherited funds to eliminate such debt provides an immediate return by stopping high interest charges, freeing up future income.

Reinforce or establish a robust emergency fund. Experts recommend setting aside funds equivalent to three to six months of living expenses in an easily accessible, liquid account, such as a high-yield savings account. This reserve acts as a buffer against unforeseen events like job loss, medical emergencies, or unexpected home repairs, preventing the need to incur new debt or disrupt long-term investments.

Distinguish between essential financial needs and discretionary desires. Addressing foundational financial security first creates a stable platform for future growth. Understanding the nature of the inherited assets, whether cash, stocks, or real estate, also provides initial context.

Strategic Allocation for Financial Goals

Beyond immediate financial needs, strategically align inherited money with your broader financial aspirations. The optimal use of these funds is highly personal, driven by your specific goals. Identifying clear financial objectives, such as saving for a home down payment, funding education, preparing for retirement, or starting a business, provides a roadmap for allocation.

The time horizon for each goal influences the allocation strategy. Short-term goals favor conservative approaches. Medium-term goals allow for a balanced approach, while long-term goals accommodate growth-oriented strategies. This ensures funds are invested with appropriate risk for when they are needed.

Your individual risk tolerance also plays a significant role in determining how inherited funds are allocated. A higher tolerance might lead to investments with greater growth potential but higher volatility. Conversely, a lower risk tolerance prioritizes capital preservation and stability. Understanding this comfort level helps in making suitable investment choices.

Diversification is a fundamental principle in strategic allocation, spreading investments across various asset classes. This approach aims to mitigate risk by ensuring that the underperformance of one investment type does not disproportionately impact the overall portfolio. Diversification creates a resilient financial structure that can withstand market fluctuations.

Integrate the inheritance thoughtfully into your existing financial plan. It can accelerate progress towards established goals, fill gaps in your current strategy, or enable new objectives. This holistic approach ensures the inherited funds contribute coherently to your overall financial journey.

Understanding Investment Vehicles

Once immediate needs are met and financial goals are established, selecting appropriate investment vehicles becomes the next focus for growing and preserving inherited wealth. Various options exist, each with distinct characteristics regarding risk, return potential, and liquidity.

Savings accounts and Certificates of Deposit (CDs) offer safety and liquidity, suitable for emergency funds or short-term goals. They prioritize capital preservation over significant growth.

Stocks represent ownership in companies and offer potential for capital appreciation and dividends. Individual stocks carry higher risk. Mutual funds and Exchange-Traded Funds (ETFs) offer diversification by pooling money from many investors to buy a basket of assets, providing professional management and spreading risk.

Bonds are debt instruments issued by governments or corporations, providing fixed income payments and generally lower risk than stocks. They add stability to a portfolio and offer predictable income streams.

Real estate can be a viable option for a primary residence down payment or as an investment property. It offers potential for appreciation and, for rental properties, can generate recurring income. However, real estate is often illiquid and involves ongoing management responsibilities and costs.

For long-term growth, particularly for retirement, utilizing retirement accounts is often advantageous due to their tax benefits. Individual Retirement Arrangements (IRAs) include Traditional and Roth options. Traditional IRA contributions may be tax-deductible, with taxes paid upon withdrawal in retirement, while Roth IRA contributions are made with after-tax money, allowing qualified withdrawals to be tax-free in retirement.

If employed, a 401(k) plan is another powerful retirement savings vehicle, especially when an employer offers matching contributions. Brokerage accounts are general investment accounts that can hold a wide range of assets, but they do not offer the specific tax advantages of retirement accounts.

Tax Implications of Inherited Assets

Understanding the tax implications of inherited assets is crucial, as they can significantly impact the net value received and how future income is taxed. In the United States, there is generally no federal inheritance tax levied on the recipient. Federal estate tax, if applicable, is paid by the deceased person’s estate before assets are distributed. Some states do impose their own inheritance taxes, paid by the beneficiary.

A significant tax advantage for inherited non-retirement assets, such as stocks or real estate, is the “stepped-up basis” rule. This rule adjusts the cost basis of the asset to its fair market value on the date of the decedent’s death. If an inherited stock was worth \$100 at death, the inheritor’s cost basis becomes \$100. If sold for \$105, capital gains tax is only on the \$5 increase. This can substantially reduce potential capital gains tax liability.

Income generated by inherited assets after they are received is generally taxable to the inheritor. This includes dividends, interest, or rental income. This income is typically reported on the inheritor’s annual tax return and taxed at their ordinary income tax rates or capital gains rates.

Inherited retirement accounts, such as IRAs and 401(k)s, have specific tax rules. For spousal beneficiaries, options include rolling the inherited IRA into their own IRA or taking distributions as a beneficiary. Rolling it into their own IRA allows deferral until their own retirement.

For non-spousal beneficiaries, most are subject to the “10-year rule.” This rule requires the entire inherited account to be fully distributed within ten years following the original owner’s death. Distributions are generally taxed as ordinary income in the year received. Understanding these rules is important to manage tax liabilities effectively.

Ongoing Management and Professional Guidance

Managing inherited funds is an ongoing process that requires regular review and adjustment. Financial plans are dynamic, necessitating periodic reassessment to ensure they remain aligned with evolving life circumstances, financial goals, and market conditions. This proactive approach helps maintain the effectiveness of your financial strategy.

Monitoring investment performance is an important component. This involves assessing how your portfolio is progressing toward your financial goals, rather than reacting to daily market fluctuations. Regular reviews allow for adjustments if certain investments are underperforming or if your risk tolerance or goals have shifted. This disciplined approach helps keep your long-term objectives in focus.

Seeking professional advice is beneficial in specific scenarios. If the inheritance is substantial or involves complex assets, a financial advisor can provide tailored guidance. Similarly, if you feel overwhelmed by financial decisions or lack sufficient knowledge, a professional can offer clarity and expertise.

Consulting a financial advisor, tax professional, or estate attorney is advisable for specific situations, such as developing an estate plan, navigating complex tax situations, or crafting specialized investment strategies. When choosing a financial advisor, prioritizing those who adhere to a fiduciary duty ensures they are legally obligated to act in your best interest. Certifications such as Certified Financial Planner (CFP) indicate a high standard of knowledge and ethics.