What to Do with Inheritance: Key Steps to Manage Your Windfall

Receiving an inheritance can present both opportunities for financial growth and challenges requiring careful management. This influx of wealth demands strategic planning to ensure the funds are used effectively and align with your personal goals. Thoughtful steps can help you maximize the benefits of your inheritance while avoiding common pitfalls.

Reviewing Financial Priorities

Reassessing your financial priorities is essential after receiving an inheritance. Start by evaluating your current financial situation, including debts, investments, and future goals. Address liabilities like credit card balances, student loans, or mortgages. Paying off high-interest debt can alleviate financial stress and improve your credit score.

Ensure your emergency fund is sufficient. Financial advisors recommend setting aside three to six months’ worth of living expenses for unexpected situations. If your emergency fund is inadequate, use part of the inheritance to strengthen this safety net. Review your insurance coverage—health, life, and property insurance—to confirm it meets your needs.

Once immediate financial concerns are resolved, focus on long-term goals such as retirement savings, education funding, or entrepreneurial ventures. Maximize contributions to tax-advantaged accounts like a 401(k) or IRA to bolster retirement savings. For 2024, contribution limits are $23,000 for 401(k) plans and $7,000 for IRAs, with higher limits for those over 50.

Evaluating Tax Obligations

Understanding the tax implications of an inheritance is critical. While cash inheritances are generally not subject to federal income tax, they may impact estate tax liability if the estate’s total value exceeds the federal exemption, set at $13 million for 2024. Consult with a tax professional to navigate the complexities and ensure compliance.

Inherited assets such as stocks, bonds, or real estate come with specific tax considerations. The stepped-up basis rule adjusts the asset’s cost basis to its market value at the time of inheritance, reducing capital gains taxes if sold. Be mindful of any state-level inheritance taxes, as rates and exemptions vary by jurisdiction.

Inherited retirement accounts also have unique tax rules. For traditional IRAs, the SECURE Act requires most beneficiaries to withdraw the entire balance within ten years, potentially affecting your tax bracket. Roth IRAs allow tax-free distributions, providing more flexibility. A clear understanding of these nuances can help you create a tax-efficient strategy.

Considering Investment Vehicles

Exploring investment options can help you manage your inheritance effectively. Diversified investments reduce risk and optimize returns. Stocks offer growth potential but carry volatility; index funds or ETFs provide broad market exposure with lower risk. Bonds, such as U.S. Treasury or municipal bonds, offer stability and predictable income, with municipal bonds often providing tax-free interest.

Real estate investment trusts (REITs) offer an alternative for those interested in real estate without direct property management. REITs distribute at least 90% of taxable income as dividends, ensuring steady income while maintaining liquidity. For international exposure, global funds provide access to emerging markets, though they carry currency risk and geopolitical considerations.

Cryptocurrencies like Bitcoin and Ethereum are modern investment options with high return potential but significant volatility. The IRS treats cryptocurrencies as property, subject to capital gains taxes upon sale or exchange. Staying informed about regulatory changes is critical for compliance and strategy.

Allocating Funds for Long-Term Goals

Allocating inheritance funds toward long-term goals requires a balanced approach. A diversified portfolio tailored to your risk tolerance and time horizon can ensure sustained growth and financial security. Diversification involves spreading investments across asset classes such as equities, fixed income, and alternative investments.

Education funding is another meaningful goal. A 529 plan provides tax advantages for educational savings, with earnings growing tax-free when used for qualifying expenses. Some states also offer tax deductions for contributions to these plans.

If entrepreneurship is a goal, your inheritance can fund business ventures. Forming a limited liability company (LLC) protects personal assets while enabling growth. Familiarize yourself with tax benefits like the 20% deduction on qualified business income under the Internal Revenue Code Section 199A to optimize your position.

Handling Real Estate and Tangible Assets

Inherited real estate and tangible assets require careful evaluation. Determine the value of real estate by consulting appraisers or real estate professionals. Consider location, market trends, and potential rental income to decide whether to sell, lease, or retain the property. Leasing can generate steady income but includes responsibilities like property management and maintenance.

Tangible assets, such as art, collectibles, or jewelry, may hold sentimental and financial value. Obtain appraisals to understand their market worth, especially if you plan to sell or insure them. Some tangible assets, like rare artwork or vintage cars, may appreciate over time but require specialized storage or insurance. Selling these assets may trigger capital gains taxes, calculated based on the stepped-up basis. Consulting a financial advisor can help balance emotional and financial considerations.

Updating Personal Estate Plans

Receiving an inheritance is an opportunity to update your estate plan to protect and distribute your wealth according to your wishes. Review your will or trust documents to incorporate newly acquired assets. Adjust beneficiary designations or create a trust, such as a revocable living trust, to manage these holdings efficiently and avoid probate.

Consider estate tax implications for your heirs. While the federal estate tax exemption is $13 million, state-level exemptions are often lower. Gifting strategies, such as utilizing the annual gift tax exclusion ($17,000 per individual for 2024), can reduce the taxable value of your estate over time. Review life insurance policies to ensure they provide liquidity for your beneficiaries or cover estate taxes. Finally, update powers of attorney and healthcare directives to reflect your current wishes and circumstances.