What to Do With an Inheritance: A Comprehensive Guide

By Pam O’Brien · January 09, 2024 · 14 minute read

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What to Do With an Inheritance: A Comprehensive Guide

Getting an inheritance can usher in a wide range of emotions.

On one hand, you’ve just lost someone close to you, and that can be very difficult to process and deal with. On the other hand, inheritance money can change lives for the better. Who hasn’t dreamed of getting a chunk of change to put toward their financial dreams?

But receiving a sudden windfall can also be unexpectedly stressful. If you mismanage an inheritance, it could leave you back where you started financially, or even create new financial problems for you.

It’s crucial to think carefully about what to do with an inheritance, and to consider all your options before you act. From paying off debt to buying a home to investing the inheritance, there are many ways to use your inheritance that may help you get ahead financially.

Here are some ideas for what to do with an inheritance, including how to think about this new money and how to invest your inheritance in your financial goals.

First Steps After Receiving an Inheritance

If you receive an inheritance, first take a breath and just sit with the news for a bit. Don’t do anything rash or you might end up regretting it.

The Importance of Slowing Down

It’s wise to take it easy right now. You’ve just lost someone close to you and you are still dealing emotionally with that. Give yourself time to grieve before making any major decisions about what to do with an inheritance. In most cases, you don’t have to do anything about the inheritance immediately, so don’t feel pressured to act right away. Instead, take your time and be strategic.

For instance, you could put the money in a high-yield savings account for the time being. Then, when you’re ready, you can start mapping out a plan for the funds.

Paying Tribute: Honoring Their Legacy in Your Decisions

Your loved one worked hard to earn or accumulate the money you’ve inherited. Take some time to feel gratitude toward them and what they’ve done for you.

Think about how they might want you to spend the money. Would they want you to put it toward your retirement savings? Buy a house so you can finally stop renting? Keeping your loved one top of mind as you plan what to do with the money, might help give you purpose and hold you accountable so that you don’t spend the inheritance frivolously.

Building Your Support Team: Financial Advisors, Lawyers, and Accountants

Inheriting money can be confusing since you probably aren’t quite sure how the process works. And you may not know the best thing to do with the funds. That’s why having some support, such as estate lawyers, accountants, or financial advisors, might be wise, especially if you’re inheriting a large sum.

But be an active participant in the process. Ask these professionals for their input and suggestions and then carefully weigh the different options. You need to make the decisions that are best for you and your situation.

💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.

Managing a Cash Inheritance

Receiving a cash inheritance is a great reason to sit down and review your financial situation and assess your current needs and priorities. Looking at your financial statements — including your income, expenses, assets, and liabilities — might be the easiest way to start.

Taking some time to think about your short-term and long-term financial goals may help define your values and guide you as you determine the best course of action for saving and investing the money. How you ultimately invest an inheritance will depend on your financial goals.

Strategies for Small, Medium, and Large Sums

What you do with your inheritance may depend on how much you inherit. If it’s a small sum, you may want to put it toward a downpayment on a house, for example. Or you could use it to build up an emergency fund.

If you inherit a medium-size sum, you may want to earmark it for your children’s college education. Or you could put it toward your own retirement savings.

And finally, if you inherit a large sum, you may want to do several different things with the money. For instance, you may decide to invest a chunk of it for your future. And you might use another portion if it to pay off your mortgage or other debts you have. Perhaps you want to donate some to charity. You could even use some of the money to take the vacation you’ve always dreamed of.

Balancing Savings, Debt Repayment, and Investments

It could be wise to make several financial moves with your inheritance to help secure your future. That way you can balance your different priorities.

Some of the money could go into your emergency savings fund so that you have a robust financial cushion in case you need it.

Another portion might go toward paying off debt, such as credit card or student loan debt. This can help free up your cash flow and even help you save more money for your future.

And you could invest the rest for retirement. You can explore the different types of retirement accounts that you may be eligible for to find the right options for you.

Retirement, Education, and Emergency Fund Priorities

Saving and investing for retirement could be an excellent use of inheritance money. As mentioned above, the first step is determining which type of account to open.

Because inherited money is not earned income, you cannot put it directly into a retirement account like a traditional or Roth IRA. However, you could open a brokerage account and build an investment portfolio for retirement. You may want to consider stocks, mutual funds, exchange-traded funds (ETFs), or a mix of all three in your portfolio.

Another priority for your inheritance might be your children’s college education. You could consider using your inherited money to fund a college savings account or invest towards your child’s future educational costs.

This can be done through a 529 plan, a prepaid tuition plan, or a Coverdell education savings account. A 529 plan allows for tax-free investment growth when the money is used for higher education expenses.

Each state has its own 529 plan, but you’re not required to use the plan for the state for which you live. Some states may offer a state income tax deduction if you use their state’s plan, so check with the plan (or your tax advisor) to be sure.

Another way you may want to use inherited money is building up an emergency fund. Just like it sounds, an emergency fund is cash, typically held in a savings account, that’s available in the event of an emergency, such as a sudden, unexpected expense like a car accident or a root canal. Having the cash available to cover such an expense may help you avoid going into credit card or other debt in the future.

While it’s ultimately up to you to determine how much money to keep in an emergency fund, you may want to consider having the recommended three to six months’ worth of expenses in the bank. This amount may help cover you in the event you are laid off from your job and need time to find a new opportunity.

Investment Opportunities for Inherited Wealth

Once you’ve paid off any debts you owe and allocated money to an emergency fund and possibly to your children’s college funds, you may want to invest the rest for your future financial goals.

Diversifying Investments: Stocks, Bonds, and Funds

Building a diversified, balanced portfolio with investments that have different degrees of risk is one strategy to consider. Diversification may help mitigate risk, though it’s important to remember that there is still risk involved with investing. Some investments with different levels of risk to explore are stocks, bonds, and mutual funds. Stocks are considered more volatile — they may potentially offer higher growth but also have higher risk — while bonds typically have lower risk and smaller returns. Mutual funds typically include a mix of stocks and bonds.

Tax-Advantaged Accounts and Minimizing Tax Burden

Inheritances are not considered taxable income for federal taxes. However, any earnings on your inherited assets are generally taxable.

Some of the most popular types of accounts that may offer tax advantages include IRAs and 401(k)s. Inheritance money per se cannot be invested in these accounts (because it’s not earned income). However, the additional money you get from an inheritance might give you the flexibility to use your income to open an IRA or contribute more to your 401(k) at work.

Here’s how: If you use inheritance money to pay down debt or pay bills, such as your mortgage, you may be able to afford to invest more of your earned income in a retirement account. Because some of these accounts are tax deferred, including traditional IRAs and 401(k)s, they may also help reduce your tax burden.

Real Estate Investments: Pros, Cons, and Considerations

If you’re thinking about investing your inheritance in real estate, you might want to consider a real estate investment trust (REIT). A REIT is a company that owns or operates properties that generate income. With a REIT, you can invest in real estate properties without having to buy actual properties and manage them yourself.

But REITS do come with risks. For instance, REITs tend to be very sensitive to changes in interest rates. When rates rise, the value of a REIT can fall. Also, commercial properties can be affected by trends. For instance, if a REIT focuses on a type of store that suddenly becomes less popular with consumers, your investment could take a hit.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

How to Handle Inherited Properties and Valuables

Part of your inheritance might include a house, a car, antiques, or jewelry. These can all be financially beneficial, depending on their value. But they can also pose challenges since you will need to decide what to do with them.

Decisions for an Inherited House: Sell, Rent, or Move In?

If you inherit a house, for instance, the big decision you’ll face is whether to move into it, rent it, or sell it.

Selling the house will provide you with a profit. You could then use that money to pay debt or invest for the future. There may also be a tax benefit. That’s because inherited homes have a step-up tax basis. That means you don’t pay taxes on the full amount of the home, but only on any amount it sold for that’s more than what the home was worth on the date your loved one died. So if the house was worth $300,000 at the time your relative died, and you sell it for $375,000, you only pay taxes on $75,000.

Just remember that you’ll have to empty out the house and get it ready to sell. You’ll also need to pay the utilities, mortgage, taxes, etc. until the house sells.

You can rent out the home instead, which could potentially give you steady rental income. However, you will need to manage the property and take care of maintenance and repairs. This could be tricky if you don’t live nearby. And even if you do, it can be time consuming. You’ll also need to figure out the tax implications of renting out the house, which may be complicated.

Finally, you may choose to move into the house. This might be a good option for you if you haven’t been able to afford buying a home of your own previously. Just remember that while you won’t have to pay a mortgage, you will have to pay such ongoing expenses as real estate taxes and homeowner’s insurance.

Inherited Vehicles and Heirlooms: Assessing Value and Sentiment

If you inherit a vehicle like a car, you’ll need to decide whether to keep it or sell it. Your decision will likely depend on the age of the vehicle and the shape it’s in. It will also hinge on whether you need or want a new car. You might be perfectly happy with your own current vehicle. In that case, you could sell the inherited car and make a profit from it.

Deciding what to do with inherited items that have sentimental value as well as monetary value — such as jewelry, antiques, or a relative’s prized collection — can be more difficult. You may feel an attachment to these items. Wait a bit before making a decision about them and give yourself time to think through the best course of action. For instance, you might want to hold onto a few items that have special meaning to you and sell the rest. Or perhaps you’ll decide you’re not ready to part with them and you’ll keep them all. Do what feels right to you.

Tax Implications of an Inheritance

There are two types of taxes related to an inheritance: estate taxes and inheritance taxes.

Estate and Inheritance Taxes: What You Need to Know

The federal government does not impose an inheritance tax. That means you won’t have to pay federal taxes on your inheritance. But keep in mind that any earnings you make from your inheritance are subject to taxes.

Some states have inheritance taxes that you may need to pay. To find out if your state is one of them, check with the state department of taxation. You might also want to consult a tax professional.

Estate taxes are a different matter. These taxes are not levied against you, the person inheriting money. Instead, they are levied against the estate of the deceased person. However, unless the estate is extremely large ($12.92 million or more in 2023, and $13.61 in 2024), the estate won’t have to pay federal estate taxes.

Capital Gains Tax: How It Affects Your Inherited Assets

Capital gains taxes are something you typically pay when you sell inheritance assets and make money on them. Thanks to what’s known as a step-up in basis, the value of the item you inherit is adjusted to its value on the date of your loved one’s death.

For example, if you inherit a house your mother bought for $100,000 and the house is worth $500,000 on her date of death, the value of the house is adjusted to $500,000. If you sell the house for that amount, there are no capital gains. If you sell the house for more than $500,000 you pay capital gains on anything over that amount.

In addition to real estate, this rule also generally applies to other things you inherit, such as stocks, mutual funds, bonds, and collectibles.

Capital gains taxes can be quite complicated, so you may want to consult a tax professional to make sure you report and pay these taxes properly.

Leveraging Professional Financial Advice

Dealing with an inheritance and all it involves can be overwhelming. A trusted advisor could help you decide what to do with the money in order to make the most of it.

Choosing the Right Advisor for Your Inheritance Needs

You may want to begin your search for an advisor with the person or people associated with the estate before it was passed along, such as the estate’s executor or a trustee.

That said, you’ll want to be certain that this person is a “fiduciary,” which means that they always act in your best financial interest.

Another option is to directly hire a financial advisor. When choosing a financial advisor, you can start by asking family, friends, and colleagues for recommendations. You can also consult industry associations such as the National Association of Personal Financial Advisors or the Financial Planning Association

The Role of Financial Planning in Estate Inheritance

A financial planner can help you create a financial plan for your inheritance based on your financial goals and your current situation.

A good financial plan can help you make the most of your money. It can allocate money to help you pay down debt and to create an emergency fund. It can also help you manage your inheritance assets. For instance, you might choose to put some of the money in investments to help reach future financial goals such as buying a house or saving for retirement.

Inheriting money requires careful decision making. That’s why having a solid financial plan in place can be so useful. It can help you stay on track to meet your goals.

Avoiding Common Mistakes with Inherited Wealth

When you receive an inheritance, it’s wise to take some time to decide the best course of action to take. This can help prevent you from doing something you may regret later. These are some common mistakes to avoid:

Failing to put together a solid financial plan. A good plan lays out your financial goals and priorities. It can help you pay off debt now and save money for your future. Without such a plan, you might end up frittering away a chunk of your inheritance before you realize it.

Making emotional decisions. Dealing with the loss of a loved one is difficult, and emotions could cloud your judgment about what to do with your inheritance. Don’t make rash decisions. Instead, put the money someplace safe for the time being, like a high-yield savings account, and give yourself time to grieve before making major decisions.

Spending too much. You may be tempted to use your windfall to purchase a boat or buy a luxury car. While these purchases are fun, they won’t help you in the long-term the way paying off debt or saving for your retirement will. Plus, cars and boats require ongoing maintenance — and even storage in the case of the boat — that you’ll need to keep paying for.

If you’re not careful, you could end up burning through your entire inheritance and not have a lot to show for it. Instead, create a financial plan as outlined above. In your plan you can set aside a small part of your inheritance for fun spending. For instance, maybe you dedicate 5% or 10% of the amount you inherited to taking that trip to Italy you’ve always dreamed of. That way you’ll be able to enjoy some of the money now and save and invest the rest for the future.

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Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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