What Should You Do When You Inherit Money?

Receiving an inheritance is a significant life event that can profoundly impact one’s future. Navigating this new financial landscape requires careful consideration to ensure the inheritance serves your long-term well-being. This process involves understanding the assets received and their financial and tax implications.

Understanding Your Inheritance

The first step is identifying the specific assets passed on. An inheritance can take many forms, including cash, real estate, stocks, bonds, mutual funds, or valuable personal property like jewelry or art. It might also include retirement accounts, such as IRAs or 401(k)s, or life insurance proceeds.

Understanding how these assets transfer is also important. Some assets, such as life insurance proceeds or certain retirement accounts, pass directly to a named beneficiary. Other assets, particularly those held solely in the deceased’s name without a designated beneficiary, go through probate. This court-supervised procedure validates the will, settles debts, and distributes assets according to the will or state law if no will exists.

Gathering necessary documentation is important. This includes obtaining certified copies of the death certificate, reviewing the deceased’s will or trust documents, and identifying the executor or trustee responsible for managing the estate. These documents provide information regarding the deceased’s final wishes and the legal framework for asset distribution. Making an initial assessment of the inheritance’s value and any conditions helps establish a clear financial picture.

Tax Implications of Inherited Assets

Understanding tax implications is important, as various taxes can apply depending on the asset type and your relationship to the deceased. The federal estate tax is levied on the total value of a deceased person’s assets before distribution to heirs. For 2025, the federal estate tax exemption amount is $13.99 million per individual, meaning most estates do not owe this tax. This tax is paid by the estate itself, not by the beneficiaries.

Some states impose their own estate taxes or an inheritance tax. An inheritance tax is levied directly on the beneficiary who receives the assets, rather than on the estate. As of 2025, six states levy an inheritance tax: Iowa (phasing out in 2025), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland is the only state that levies both an estate tax and an inheritance tax. Spouses are exempt from inheritance taxes in all these states, and some extend exemptions to other immediate relatives.

The tax treatment of inherited assets can vary significantly depending on the asset type. Inherited retirement accounts, such as IRAs or 401(k)s, become taxable as ordinary income when distributions are taken. For non-spouse beneficiaries, a “10-year rule” applies, requiring the account to be fully distributed by the end of the tenth year following the original owner’s death. Exceptions exist for certain “eligible designated beneficiaries,” including surviving spouses, minor children, disabled or chronically ill individuals, and those not more than 10 years younger than the original owner. These beneficiaries may stretch distributions over their own life expectancy.

For appreciated assets like stocks or real estate, the “stepped-up basis” rule offers a tax advantage. This rule resets the asset’s cost basis to its fair market value on the date of the original owner’s death. If you sell the inherited asset shortly after inheriting it, the capital gains tax liability is minimal or eliminated, as the gain is calculated from the stepped-up value, not the original purchase price. Inherited cash and life insurance proceeds paid to a named beneficiary are not subject to income tax. However, any interest accrued on life insurance installments may be taxable.

Strategic Financial Management

After understanding your inheritance and its tax implications, develop a strategic plan for managing these funds. A first step involves addressing high-interest debt, such as credit card balances or personal loans. Using a portion of the inheritance to eliminate these debts can provide immediate financial relief and free up future cash flow, improving your overall financial health.

Building or strengthening your emergency fund is another important consideration. Financial experts recommend having three to six months’ worth of living expenses readily accessible. An inheritance can provide an opportunity to establish this safety net, offering peace of mind and protection against unexpected financial challenges. This fund helps avoid taking on new debt or disrupting long-term investments during unforeseen circumstances.

When considering investments, align decisions with your personal financial goals. Whether your objectives include saving for retirement, a down payment on a home, or funding education, your investment strategy should reflect these aspirations. Diversification is a principle of investing, involving spreading investments across various asset classes, industries, and geographic regions. This approach helps mitigate risk by reducing the impact of poor performance in any single investment.

Assessing your personal risk tolerance is also an important part of investment planning. Your comfort level with potential fluctuations in investment value should guide your choices, helping to determine an appropriate mix of conservative and growth-oriented assets. Considering your investment horizon, or the length of time you plan to hold an investment, is also important. Longer time horizons may allow for greater risk-taking, as there is more time to recover from market downturns, while shorter horizons call for more conservative strategies.

Seeking Professional Guidance

Navigating the complexities of an inheritance benefits from professional guidance. Seeking help is beneficial with large inheritances, complex assets, or when facing tax implications. Professionals can help clarify your financial situation and guide you toward informed decisions.

Various types of professionals offer specialized expertise. Financial advisors and planners can assist with overall financial planning, including developing investment strategies tailored to your goals and risk tolerance. They can help integrate your inherited assets into your existing financial picture, ensuring a cohesive approach to wealth management.

Tax professionals, such as Certified Public Accountants (CPAs) or Enrolled Agents, are helpful for understanding and complying with inheritance tax rules. They can provide specific advice on minimizing tax liabilities, reporting inherited income correctly, and navigating the complexities of federal and state tax laws. Estate attorneys specialize in the legal aspects of inheritance, offering guidance on understanding wills and trusts, navigating the probate process, and resolving any legal complexities related to the inherited assets. Their expertise ensures that all legal requirements are met and that your rights as a beneficiary are protected.