What to Do With an Inheritance or Financial Windfall

Receiving an inheritance can be bittersweet. It often comes after the loss of a loved one, bringing grief alongside unexpected financial resources. You may also feel pressure, from yourself or others, to make decisions quickly. Whether you receive a modest sum or a substantial windfall, a steady, thoughtful approach can help you honor your loved one and make the most of the money.

Pause first

There’s rarely a need to make big financial decisions right away. Many financial advisers suggest waiting several months before making major moves with an inheritance or windfall. This pause gives you time to grieve, process emotions and think clearly before committing to decisions that could have long-term consequences.

During this time, avoid making large purchases, quitting your job, lending money to friends or family or making significant investment changes based on emotion or pressure.

Keep the money safe while you plan

While you plan, keep the money in a federally insured savings account, money market account or similar low-risk place. FDIC insurance at banks and NCUA insurance at credit unions protect deposits up to legal limits per depositor, per insured institution, for each account ownership category. If you’ve received a large sum, you may need to spread money across multiple institutions or account types to stay within insured limits.

Keeping the money in a safe, accessible place gives you flexibility while you develop a plan.

Understand the taxes

Taxes on inheritances can be confusing, and understanding the rules can help you avoid costly mistakes.

Federal estate tax applies only to very large estates above the federal exemption amount, and it’s generally paid by the estate before assets are distributed, not by heirs.

A few states have estate taxes, which are paid by the estate, or inheritance taxes, which are paid by heirs based on what they receive and their relationship to the deceased. Close relatives, like spouses and children, are often exempt or taxed at lower rates in states with inheritance taxes.

Inherited retirement accounts have specific withdrawal rules. Many non-spouse beneficiaries must empty inherited IRAs and 401(k)s within 10 years of the original owner’s death, under rules established by the SECURE Act. Some beneficiaries may also be required to take annual distributions during that period, depending on the circumstances. Withdrawals from inherited traditional accounts are generally taxable as ordinary income, while qualified withdrawals from inherited Roth accounts are generally tax-free. Spouses who inherit retirement accounts have additional options, such as rolling the account into their own IRA.

Planning when to take withdrawals from inherited retirement accounts can help manage taxes, such as spreading withdrawals across multiple years to avoid jumping into a higher tax bracket.

Inherited investments, such as stocks and real estate, may receive a stepped-up cost basis, meaning their cost basis is adjusted to their value at the date of death. This can significantly reduce or eliminate capital gains tax if you sell them.

Life insurance proceeds received as a beneficiary are generally not subject to income tax.

Check irs.gov or talk with a tax professional before withdrawing money or selling inherited assets.

Strengthen your financial foundation

Once you’ve had time to think, consider using your inheritance to strengthen your financial foundation.

Pay off high-interest debt, such as credit cards, which provides a guaranteed return equal to the interest rate and frees up monthly cash flow.

Build or complete your emergency fund, providing a cushion for unexpected expenses.

Boost retirement savings by maximizing contributions to retirement accounts. If the inheritance allows you to cover living expenses, you might increase your workplace retirement contributions.

Fund other goals, like a home down payment, education for yourself or your children or starting a business.

Invest for the long term in a diversified portfolio aligned with your goals and risk tolerance.

Honor your loved one

Many people find meaning in using part of an inheritance in a way that honors the person who left it, such as donating to a cause they cared about, funding a family tradition or using it for something they would have valued. Setting aside a modest portion for something meaningful or enjoyable can be part of a healthy approach.

Watch for pressure

When people learn you’ve received an inheritance, friends, family and salespeople may approach you with requests, investment ideas or products. Some may have good intentions, while others may not.

It’s okay to say, I’m taking time to make a plan. You don’t owe anyone an immediate decision. Be especially cautious of unsolicited investment offers, pressure to act quickly and promises of high returns, which are common signs of scams.

Consider the emotional side

Inheritances can bring complex emotions, such as guilt, anxiety or a sense of responsibility to use the money perfectly. Some people feel conflicted about benefiting from a loved one’s death. These feelings are normal. Talking with trusted friends, family or a counselor can help.

Get help

A fee-only fiduciary financial planner, who is required to act in your best interest and doesn’t earn commissions, can help you create a plan for your inheritance. A tax professional can help you understand tax implications and plan withdrawals or sales. For larger inheritances, an estate planning attorney can help you update your own estate plan. Taking time and getting good advice can help you make the most of a windfall and build lasting financial security.