What Should You Do With Inherited Money?

Receiving inherited money often comes with a mix of emotions, marking a significant life event that can bring both comfort and new responsibilities. While the personal aspect of an inheritance is profound, it also represents a substantial financial opportunity that requires careful consideration. Approaching this influx of funds with a thoughtful, structured plan is important to ensuring it serves your long-term financial well-being. This article will guide you through the process of navigating an inheritance, from initial steps to strategic financial planning, providing insights to help you make informed decisions.

Immediate Actions and Considerations

Upon receiving an inheritance, it is prudent to pause and avoid making any immediate, significant financial decisions. Taking time to process the inheritance allows for a clearer perspective on how these funds can best serve your financial goals. This initial period is important for gathering information and understanding the specifics of what you have received.

One of the first steps involves understanding the nature of the inherited assets, whether they are cash, real estate, investment accounts, or other valuables. Identifying any immediate tax implications is also important, though the recipient of an inheritance does not pay federal income tax on the inherited assets themselves in the United States. However, the estate from which the assets were received may have been subject to federal estate tax if its value exceeded a certain threshold, the approximately $13.61 million federal exemption per individual for 2024.

It is also important to consider that while the inheritance itself is not taxable income to the beneficiary, any future income generated by the inherited assets, interest, dividends, or rental income, will be subject to income tax. If you later sell inherited assets, any appreciation in value from the date of the decedent’s death could be subject to capital gains tax. Organizing all relevant documentation, including legal papers, account statements, and appraisal documents, is an important step to ensure a smooth transition and proper accounting of the inheritance.

Establishing Financial Priorities

With the initial administrative steps addressed, the next phase involves strategically establishing your financial priorities to leverage the inherited funds effectively. This process begins with a thorough assessment of your current financial health and identifying areas where the inheritance can provide the most immediate benefit. Addressing existing financial burdens can often yield significant long-term advantages.

A primary consideration should be the repayment of high-interest consumer debt, such as credit card balances or personal loans, which carry annual interest rates ranging from 15% to over 30%. Eliminating these liabilities can free up substantial cash flow that was previously allocated to interest payments, thereby improving your monthly budget and reducing financial stress. The guaranteed return from avoiding high-interest debt is often more beneficial than potential investment returns in uncertain market conditions.

Building or reinforcing an emergency fund is another priority. Financial experts recommend maintaining an emergency savings account that covers three to six months of essential living expenses. This fund acts as a financial safety net, providing security against unexpected events like job loss, medical emergencies, or unforeseen home repairs, preventing the need to incur new debt or liquidate long-term investments prematurely.

Beyond addressing immediate needs, the inheritance provides an opportunity to define and pursue your short-term and long-term financial goals. This includes aspirations such as making a down payment on a home, funding educational pursuits, or significantly boosting your retirement savings. Clearly articulating these goals will help guide the allocation of your inherited funds, ensuring that decisions align with your broader financial aspirations and contribute to your overall financial security.

Investing for Long-Term Growth

Once immediate financial priorities are addressed, inherited funds can be strategically invested to foster long-term growth and wealth accumulation. A principle in investment is diversification, which involves spreading investments across various asset classes to mitigate risk. This approach helps protect your portfolio from significant losses if one particular asset class or industry experiences a downturn.

Common investment vehicles suitable for long-term growth include stocks, which represent ownership in companies and offer potential for capital appreciation and dividends. Bonds are debt instruments issued by governments or corporations, providing fixed income payments and lower risk compared to stocks. Mutual funds and exchange-traded funds (ETFs) are diversified portfolios of stocks, bonds, or other assets managed by professionals, offering an accessible way to achieve diversification.

Real estate can also serve as an investment, either through direct ownership of properties or via real estate investment trusts (REITs), which are companies that own or finance income-producing real estate across a range of property types. Utilizing tax-advantaged retirement accounts, Individual Retirement Arrangements (IRAs) or employer-sponsored 401(k)s, can further enhance long-term growth by offering tax deductions on contributions or tax-free growth and withdrawals in retirement, depending on the account type. Contributions to these accounts are subject to annual limits, the $7,000 IRA contribution limit for individuals under 50 in 2024.

Assessing your personal risk tolerance is an important step in aligning your investment choices with your comfort level regarding potential fluctuations in investment value. This assessment helps determine an appropriate asset allocation strategy, balancing higher-risk, higher-reward assets with more conservative options. Your investment horizon, which is the amount of time you plan to hold your investments, also significantly influences this strategy. A longer time horizon allows for greater risk-taking, as there is more time to recover from market downturns, while a shorter horizon may necessitate a more conservative approach to protect capital.

Utilizing Funds and Seeking Expertise

Beyond investing for growth, inherited funds can be strategically utilized to achieve significant life goals or contribute to a lasting legacy. Using a portion of the inheritance for major life milestones, a down payment on a home, funding higher education, or providing capital to start a business, can profoundly impact your quality of life and future opportunities. These uses represent substantial investments in yourself or your family’s future.

Considering charitable donations can also be a meaningful way to honor the legacy of the person who left the inheritance while supporting causes important to you. Such contributions may offer tax benefits, as qualified charitable donations can be deducted from taxable income, reducing your overall tax liability. The specific tax advantages depend on the type of donation and the recipient organization.

If you consider gifting money to others, it is important to be aware of potential gift tax implications. In the United States, individuals can gift a certain amount each year, known as the annual gift tax exclusion, without incurring gift tax or affecting their lifetime gift tax exemption. For 2024, this annual exclusion is $18,000 per recipient. Gifts exceeding this amount in a single year to one individual require filing a gift tax return, though they only reduce your lifetime gift and estate tax exemption rather than incurring immediate tax, unless the lifetime exemption has already been exhausted.

Navigating the complexities of an inheritance, from tax implications to investment strategies and long-term planning, benefits significantly from professional guidance. Consulting with a qualified financial advisor can help you develop a comprehensive financial plan tailored to your specific circumstances and goals, integrating the inherited funds effectively. A tax professional or certified public accountant (CPA) can provide advice on minimizing tax liabilities related to the inheritance, including income tax on gains and potential estate or gift tax considerations. Additionally, an estate attorney can offer guidance on any legal aspects of the inheritance, such as trusts or wills, ensuring all actions comply with legal requirements and best practices.

Citations

The IRS provides guidance on inherited property basis, stating that the basis of inherited property is usually the fair market value of the property on the date of the individual’s death. Future gains are taxed.
The IRS announces annual inflation adjustments for many tax provisions, including the estate and gift tax exclusion. The exclusion for 2024 is approximately $13.61 million.
The IRS announces cost-of-living adjustments affecting dollar limitations for pension plans and other retirement-related items. The IRA contribution limit for 2024 is $7,000 for those under 50.
The IRS announces annual inflation adjustments for many tax provisions, including the annual gift tax exclusion. The exclusion for 2024 is $18,000.
The IRS announces annual inflation adjustments for many tax provisions, including the estate and gift tax exclusion. The lifetime exclusion for 2024 is approximately $13.61 million. Receiving inherited money often comes with a mix of emotions, marking a significant life event that can bring both comfort and new responsibilities. While the personal aspect of an inheritance is profound, it also represents a substantial financial opportunity that requires careful consideration. Approaching this influx of funds with a thoughtful, structured plan is paramount to ensuring it serves your long-term financial well-being. This article will guide you through the process of navigating an inheritance, from initial steps to strategic financial planning, providing insights to help you make informed decisions.

Establishing Financial Priorities

With the initial administrative steps addressed, the next phase involves strategically establishing your financial priorities to leverage the inherited funds effectively. This process begins with a thorough assessment of your current financial health and identifying areas where the inheritance can provide the most immediate benefit. Addressing existing financial burdens can often yield significant long-term advantages.

A primary consideration should be the repayment of high-interest consumer debt, such as credit card balances or personal loans, which often carry annual interest rates ranging from 15% to over 30%. Eliminating these liabilities can free up substantial cash flow that was previously allocated to interest payments, thereby improving your monthly budget and reducing financial stress. The guaranteed return from avoiding high-interest debt is often more beneficial than potential investment returns, particularly in uncertain market conditions.

Building or reinforcing a robust emergency fund is another foundational priority. Financial experts commonly recommend maintaining an emergency savings account that covers three to six months of essential living expenses. This fund acts as a vital financial safety net, providing security against unexpected events like job loss, medical emergencies, or unforeseen home repairs, preventing the need to incur new debt or liquidate long-term investments prematurely.

Beyond addressing immediate needs, the inheritance provides an opportunity to define and pursue your short-term and long-term financial goals. This includes aspirations such as making a down payment on a home, funding educational pursuits, or significantly boosting your retirement savings. Clearly articulating these goals will help guide the allocation of your inherited funds, ensuring that decisions align with your broader financial aspirations and contribute to your overall financial security.

Investing for Long-Term Growth

Once immediate financial priorities are addressed, inherited funds can be strategically invested to foster long-term growth and wealth accumulation. A fundamental principle in investment is diversification, which involves spreading investments across various asset classes to mitigate risk. This approach helps protect your portfolio from significant losses if one particular asset class or industry experiences a downturn.

Common investment vehicles suitable for long-term growth include stocks, which represent ownership in companies and offer potential for capital appreciation and dividends. Bonds are debt instruments issued by governments or corporations, providing fixed income payments and generally lower risk compared to stocks. Mutual funds and exchange-traded funds (ETFs) are diversified portfolios of stocks, bonds, or other assets managed by professionals, offering an accessible way to achieve diversification.

Real estate can also serve as an investment, either through direct ownership of properties or via real estate investment trusts (REITs), which are companies that own or finance income-producing real estate across a range of property types. Utilizing tax-advantaged retirement accounts, such as Individual Retirement Arrangements (IRAs) or employer-sponsored 401(k)s, can further enhance long-term growth by offering tax deductions on contributions or tax-free growth and withdrawals in retirement, depending on the account type. Contributions to these accounts are subject to annual limits, such as the $7,000 IRA contribution limit for individuals under 50 for 2024.

Assessing your personal risk tolerance is a critical step in aligning your investment choices with your comfort level regarding potential fluctuations in investment value. This assessment helps determine an appropriate asset allocation strategy, balancing higher-risk, higher-reward assets with more conservative options. Your investment horizon, which is the amount of time you plan to hold your investments, also significantly influences this strategy. A longer time horizon generally allows for greater risk-taking, as there is more time to recover from market downturns, while a shorter horizon may necessitate a more conservative approach to protect capital.