What Should You Do With an Inheritance?
Received an inheritance? Learn how to thoughtfully plan and strategically manage these funds for lasting financial security and growth.
Receiving an inheritance can represent a significant life event, offering an opportunity to shape one’s financial future. This influx of assets, regardless of its size, necessitates careful consideration and strategic planning. Thoughtful decisions at this juncture can contribute to long-term financial stability and the achievement of personal goals. Approaching an inheritance with a clear strategy, rather than reacting impulsively, allows for a more beneficial outcome.
Immediate Steps After Receiving an Inheritance
Upon receiving an inheritance, allow time for emotional and practical processing. Major financial decisions should not be rushed, as this period often involves a mix of emotions alongside new financial realities. Understanding the specific details of the inherited assets is a primary step, which includes identifying the types of assets received, such as cash, real estate, or investment accounts, and any conditions or trusts associated with them.
Establishing a separate, temporary holding account for any cash inheritance is advisable to prevent commingling these funds with existing personal finances. This segregation provides a clear overview of the inherited amount and helps in tracking its eventual allocation. Gathering all necessary documentation, such as wills, trust documents, death certificates, and statements from financial institutions.
An initial consultation with an estate attorney or a financial advisor can provide clarity on the inheritance process itself. This discussion focuses on understanding the legal and administrative aspects, rather than immediately deciding how to deploy funds. Professional guidance ensures procedural requirements are met and assets are secured in the beneficiary’s name. This work sets the stage for informed financial planning.
Managing Debt and Building Financial Security
Utilizing an inheritance to strengthen one’s financial foundation is an effective strategy. A primary consideration involves addressing high-interest consumer debt, such as credit card balances or personal loans. With average interest rates from 20% to over 25% annually, these debts are costly. Eliminating such obligations can free up significant cash flow and improve overall financial health.
Establishing or bolstering an emergency fund provides a financial safety net. Experts recommend holding three to six months’ worth of living expenses in an easily accessible account for unforeseen events. This fund should cover essential expenditures like housing, utilities, food, and existing debt payments, protecting against unexpected job loss, medical emergencies, or significant repairs. Building this reserve reduces reliance on debt during difficult times.
Reviewing and potentially increasing insurance coverage can further protect assets and income. This includes evaluating policies such as life insurance, health insurance, disability insurance, and property insurance for adequate protection. Addressing any urgent, short-term financial needs or outstanding obligations also contributes to a stable financial base. Prioritizing these areas before considering long-term investments helps create a more secure financial future.
Investing for Future Growth
Once immediate financial security is established, an inheritance can be strategically deployed for long-term wealth accumulation. Defining clear financial goals, such as saving for retirement, a child’s education, or a significant purchase like a home, provides direction for investment decisions. Diversification across different asset classes is a principle in investment planning, reducing risk by spreading investments across various asset types.
Common investment options include stocks (ownership in companies) and bonds (loans to governments or corporations). Mutual funds and exchange-traded funds (ETFs) offer diversified portfolios managed by professionals, providing an accessible way to invest across many securities. While real estate can be a viable investment, it often involves higher complexity and illiquidity.
Utilizing tax-advantaged retirement accounts is a highly recommended strategy for long-term growth. Contributions to accounts like Individual Retirement Arrangements (IRAs) and 401(k)s offer tax benefits, such as tax-deductible contributions or tax-free growth. Understanding personal risk tolerance guides investment selection that aligns with comfort levels regarding potential value fluctuations. Professional financial advice is particularly valuable for developing a comprehensive investment strategy tailored to individual circumstances and goals.
Understanding Tax Implications
A common misconception is that all inheritances are subject to federal income tax. Inherited cash or property is generally not considered taxable income at the federal level. However, any income generated by inherited assets after receipt, such as interest or dividends, is taxable to the beneficiary.
While there is no federal inheritance tax, a few states levy such taxes, paid by the beneficiary. As of 2025, states like Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania may impose an inheritance tax, with Iowa phasing out its tax. Applicability and rates often depend on the beneficiary’s relationship to the deceased, with close family members frequently exempt or taxed at lower rates.
The “step-up in basis” is a tax rule for inherited appreciated assets like stocks or real estate. This rule adjusts the asset’s cost basis to its fair market value on the date of death. This adjustment can substantially reduce potential capital gains taxes if the beneficiary later sells the asset, as taxes are calculated only on appreciation since the date of death.
Inherited retirement accounts, such as traditional IRAs or 401(k)s, have specific tax rules, including required minimum distributions (RMDs) for non-spouse beneficiaries, who typically must withdraw the entire account balance within a 10-year period. Federal estate tax applies only to very large estates, with an exemption of $13.99 million per individual in 2025 (increasing to $15 million in 2026), and is paid by the estate itself, not the beneficiary.