What Should I Do With an Inheritance?

Receiving an inheritance is a significant financial moment, offering opportunities to strengthen your financial standing and pursue aspirations. Careful planning is important to manage these assets effectively, aligning with your goals and securing your financial future.

Understanding Your Inheritance

An inheritance can take various forms. These include:
Liquid assets like cash, stocks, and bonds.
Tangible properties such as real estate.
Financial instruments like annuities and life insurance payouts.
Retirement accounts, including IRAs and 401(k)s.
Personal property like artwork or jewelry.
Identifying the specific types of assets received is the first step in managing your inheritance.

Verifying the inheritance involves examining legal documents like a will, trust, or beneficiary designations. For estates subject to probate, a court-supervised process confirms the will’s validity and oversees asset distribution. This ensures proper asset transfer and clarifies any conditions. Securing physical assets and formally transferring financial assets, such as updating account ownership, are early steps.

For inherited non-retirement assets, the “step-up in basis” rule adjusts the cost basis to its fair market value on the date of the original owner’s death. This can significantly reduce capital gains taxes if you later sell the asset, as tax is only owed on appreciation occurring after the inheritance date. For example, if property bought for $100,000 is worth $500,000 at inheritance, your new tax basis becomes $500,000, and only gains above that amount are taxable upon sale.

Inherited traditional IRAs and similar retirement accounts do not receive a step-up in basis. Consulting an estate attorney or financial advisor can provide clarity on the asset nature and guide you through initial administrative and legal requirements.

Strategic Financial Allocation

A strategic approach to financial allocation can enhance your financial well-being. Prioritizing repayment of high-interest debt, such as credit card balances or personal loans, can immediately free up future cash flow and reduce financial stress. Eliminating these obligations often provides a “return” that outperforms many investment opportunities.

Building an emergency fund is a foundational step for financial stability. Setting aside three to six months’ worth of living expenses in an accessible, interest-bearing account provides a financial safety net, protecting against unforeseen expenses and preventing new debt.

Contributing to retirement accounts, such as IRAs or 401(k)s, allows your inheritance to grow tax-advantaged over time. Maximizing contributions up to annual limits can lead to substantial wealth accumulation due to compounding. For 2025, the IRA contribution limit is $7,000 ($8,000 if age 50 or older), while the 401(k) limit is $23,000 ($30,500 if age 50 or older).

Beyond debt reduction and emergency savings, consider allocating funds towards specific personal goals. This could include saving for a home down payment, funding education, or starting a business. Integrate these goals into a comprehensive personal budget.

For remaining funds, investing plays a significant role in long-term wealth growth. A diversified investment strategy, spread across various asset classes like stocks, bonds, and mutual funds, can help manage risk while pursuing growth. Your investment approach should align with your comfort level with market fluctuations and long-term financial objectives.

Making large purchases, such as a home or vehicle, should be evaluated within your overall financial plan. Consider the ongoing costs and how they fit into your budget before committing a substantial portion of your inheritance.

Consulting a qualified financial advisor is advisable for personalized planning. A financial professional can help assess your circumstances, clarify goals, and develop a tailored strategy for allocating inherited assets.

Tax Implications of Inherited Assets

Different inherited asset types have varying tax treatments. Distributions from inherited retirement accounts, such as traditional IRAs and 401(k)s, are generally taxable as ordinary income. Rules for Required Minimum Distributions (RMDs) depend on your relationship to the original account owner and when they passed away.

For most non-spousal beneficiaries of inherited IRAs, the Secure Act mandates the entire account balance be distributed by the end of the tenth year following the original owner’s death. If the original owner had already begun RMDs, the non-spousal beneficiary may also need to take annual RMDs during this 10-year period. Spouses often have more flexibility, able to roll over the inherited IRA into their own account, delaying distributions until their own RMD age.

Capital gains tax applies to inherited non-retirement assets, such as stocks or real estate, only when sold for a profit above their stepped-up basis. This means appreciation during the original owner’s lifetime is not subject to capital gains tax for the inheritor. Only appreciation from the date of inheritance to the date of sale is taxable.

Federal estate tax applies only to very large estates, with a high exemption amount. For individuals, the federal estate tax exemption is $13.99 million for 2025. This exemption is effectively doubled for married couples. Some states may impose their own estate or inheritance taxes, which can apply at lower thresholds.

Inheritors may receive various tax forms, such as Form 1099-R for retirement account distributions or Form 1099-B for sales of brokerage assets. These forms report taxable income on your annual tax return. Consulting a qualified tax professional is recommended to ensure compliance and optimize your tax strategy.

Considering Gifting and Philanthropy

An inheritance can also provide an opportunity to support others through gifting or charitable contributions. The annual gift tax exclusion allows you to give a certain amount to any individual each year without incurring gift tax for the giver. For 2025, this exclusion is $19,000 per recipient. Married couples can combine their exclusions to give $38,000 per recipient.

Gifts exceeding this annual exclusion must be reported to the IRS on Form 709, but typically do not result in immediate gift tax unless your total lifetime gifts surpass the lifetime gift tax exemption. Any gifts over the annual exclusion reduce this lifetime exemption.

Charitable donations offer potential tax deductions. You can make direct cash contributions to qualified charities or donate appreciated assets like stocks, which can offer additional tax benefits by avoiding capital gains tax on donated assets. Donor-advised funds (DAFs) are a popular vehicle, permitting an immediate tax deduction upon contribution while allowing you to recommend grants to charities over time.

Gifting can also be integrated into family financial planning, such as assisting family members with education costs or a home down payment. Consult a financial advisor or tax professional before making significant gifts or donations. These professionals can help you understand tax implications, ensure proper documentation, and align generosity with your financial objectives.