What to Do with Inheritance: Your Financial Roadmap
- Reviewed by: Chad Seegers, CRPC®
- September 16, 2024
Receiving an inheritance can be both an emotional and financial turning point in life. It often comes during a time of loss, making it difficult to navigate the complexities of managing your new wealth. Whether it’s a substantial amount or a smaller sum, an inheritance presents an opportunity to improve your financial future—but only with careful planning. Thoughtful decisions about how to use, invest, or preserve the funds are key to ensuring your inheritance supports your long-term goals and legacy.
What Should You Do First After Receiving an Inheritance?
The first step after receiving an inheritance is to take time to fully assess its value. This means understanding all components, whether they include cash, investments, property, or other assets. Avoid the temptation to make rushed financial decisions, as emotions can cloud judgment during this period. Instead, take a pause to ensure you are making thoughtful choices.
It’s also wise to consult with a financial advisor to help you create a clear plan moving forward. But, what does a financial advisor do when it comes to helping you navigate such a situation? A financial advisor can guide you in maximizing the potential of your inheritance while aligning it with your long-term financial goals. If you’re looking for knowledgeable advice, check out our financial planning services in Houston or San Ramon.
Prioritize Your Financial Goals
One of the most important steps after receiving an inheritance, especially a large inheritance, is to prioritize your financial goals. Start by addressing any high-interest debts, such as credit cards or personal loans. Paying these off can significantly reduce financial strain and free up more of your inheritance for long-term planning.
Next, take a close look at your emergency fund. If you don’t have one, or if it’s underfunded, you can use a portion of your inheritance to build or bolster this financial safety net. Having three to six months’ worth of living expenses set aside will provide peace of mind and help protect you from unexpected financial setbacks.
Consider saving and investing for future goals, such as retirement, education, or other milestones. An inheritance provides an excellent opportunity to boost your retirement accounts or start an investment plan that can grow over time, helping to secure your financial future. Working with a certified financial advisor will help you decide what to do with inheritance in a way that aligns with your goals.
What Should You Not Do with an Inheritance?
When receiving an inheritance, it’s essential to approach spending with caution. While it can be tempting to indulge in large purchases or lifestyle upgrades, impulsive spending can quickly deplete your inheritance. Taking time to reflect on your financial needs and goals will help you avoid decisions that may not serve your long-term interests.
Equally important is consulting with financial professionals. Navigating the complexities of an inheritance—whether it’s tax implications, investment strategies, or estate planning—can be overwhelming. A financial advisor can offer tailored guidance, ensuring you make informed decisions that align with your overall financial plan.
You will also want to be wary of high-risk investments and understand your risk tolerance. Although it may seem like an opportunity to grow your inheritance quickly, such strategies can expose you to unnecessary risks. By prioritizing a balanced and diversified approach, you can protect your wealth while positioning it for steady, long-term growth.
Do I Need to Report Inheritance Money to the IRS?
Understanding inheritance tax laws is an important part of managing the financial impact of an inheritance. The good news is that in most cases, inheritance money itself is not subject to federal income tax1. However, certain assets, such as inherited retirement accounts, may be taxed as you withdraw funds. Estate taxes may also apply at the state or federal level if the total value of the estate exceeds certain thresholds.
It’s important to differentiate between taxable and non-taxable assets. For example, cash and property you inherit are generally not taxed, but income generated from those assets, like interest or rental income, is taxable. Similarly, inherited IRAs or 401(k)s are subject to specific tax rules, which may require you to take distributions and pay taxes on them.
When it comes to reporting, while you don’t have to report inheritance money directly to the IRS, any taxable income derived from inherited assets must be included on your tax return2. If you’re unsure about what to report and when, consulting with a tax professional is the best way to ensure compliance with IRS regulations.
How Much Inherited Money Is Tax-Free?
When it comes to inheritance, most people won’t have to worry about federal estate taxes, as the federal tax threshold is quite high. As of 2024, estates valued under $13.61 million per individual are exempt from federal estate taxes3. However, individual states may have lower thresholds for estate or inheritance taxes, so it’s important to be aware of your state’s specific tax laws to determine if your inheritance is subject to state taxes.
Certain assets, such as life insurance proceeds, are typically exempt from both federal and state taxes, while others, like retirement accounts, may be taxed when distributions are taken. Additionally, some states provide exemptions for spouses and direct heirs, meaning they may be taxed at a lower rate or not at all, depending on the asset type and relationship to the deceased.
Do Beneficiaries Get Taxed on Inheritance?
Beneficiaries typically don’t pay federal taxes on the assets they inherit, as the responsibility for any applicable estate taxes falls on the estate itself before distributions are made. However, this doesn’t mean that beneficiaries are entirely exempt from taxes. Some states impose inheritance taxes, which require beneficiaries to pay taxes on the value of the assets they receive. These taxes vary depending on the state and the beneficiary’s relationship to the deceased.
In states where inheritance tax applies, immediate family members, such as spouses or children, often face lower tax rates or are fully exempt, while other heirs may be taxed at higher rates. Certain types of assets, such as inherited retirement accounts, may be subject to income tax as funds are withdrawn. Understanding the specific tax obligations based on your state and the type of assets received is crucial for effective financial planning.
Building a Long-Term Financial Plan with Your Inheritance
One of the best ways to use your inheritance is to build a solid long-term financial plan. Start by establishing or strengthening your emergency fund. Setting aside three to six months’ worth of living expenses can provide financial stability and protection from unexpected events, helping you avoid debt in times of crisis.
Consider using part of your inheritance to pay off existing debts and liabilities, especially high-interest obligations like credit card balances or personal loans. Reducing or eliminating these debts frees up your future cash flow and reduces financial stress, allowing you to focus on other financial goals.
Finally, investing your inheritance is a key strategy to grow your wealth over time. Whether through retirement accounts, stocks, or other investments, your inheritance can be an opportunity to build long-term financial security. Working with a financial advisor can help you create a diversified investment plan tailored to your goals, ensuring your inheritance grows while balancing risk.
Charitable Giving and Legacy Planning
Inheriting wealth offers the opportunity to make a meaningful impact through charitable giving. Donating part of your inheritance to causes that matter to you not only benefits those in need but can also provide tax benefits, depending on how and where you give. Whether it’s a one-time donation or setting up a charitable foundation, giving back can be a rewarding way to honor your loved one’s legacy while supporting the greater good.
At the same time, it’s important to think about your own estate and legacy planning. Using your inheritance as a foundation, you can plan to pass on wealth to future generations in a tax-efficient way. Establishing a will or trust, and working with an estate planning attorney, can help ensure your assets are distributed according to your wishes and protected from unnecessary taxes or legal complications. By planning ahead, you can build a legacy that extends beyond your own lifetime, providing for your heirs and continuing the cycle of giving.
How Insight Wealth Strategies Can Help You Maximize Your Inheritance
At Insight Wealth, we understand that every inheritance is unique, and so are your financial goals. Our tailored wealth management and financial planning solutions are designed to help you make the most of your inherited wealth, whether it’s building a long-term investment strategy, paying off debt, or planning your legacy for future generations. Learn more about how we can help by exploring our wealth management services in Houston or our San Ramon office.
Reviewed by,
Chad Seegers, CRPC®
Chad began his career with Sagemark Consulting in 2005 and then became a Select member of Sagemark’s Private Wealth Services which operated as a national resource for financial planners focusing on Advanced Strategies in the High Net Worth marketplace. Chad then began his partnership with Insight Wealth Strategies in 2013 focused on retirement planning primarily with Oil and Gas employees and executives. His primary areas of expertise are retirement, estate, and investment strategies as he serves as Investment Strategist for the financial planning team.
Insight Wealth Strategies, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Insight Wealth Strategies, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Insight Wealth Strategies, LLC unless a client service agreement is in place.
Insight Wealth Strategies, LLC (IWS) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
