You just received an inheritance, and you may be thinking, “What do I do after receiving an inheritance?”
You might be filled with conflicting emotions. Losing someone is hard. Receiving money because they died can come with a world of emotions — guilt, sadness, or others.
I’ve been there. I lost my dad and received an inheritance, and despite having worked with people who have received an inheritance and knowing what to do, it was still challenging.
Before you do anything with your inheritance, take a moment to understand your options, the tax consequences, how using it to pay down debt may affect you, and ideas for how to use the inheritance to strengthen your financial future.
Once you know the options and acknowledge the emotions that come with the inheritance, it’s easier to make a plan for what to do with it.
Don’t Rush, Take Some Time
The first step is to take a moment and recognize you don’t have to do anything immediately. It may feel like you need to do something now, but you don’t.
When we lose someone we love, our brains are rarely operating at 100%. There is grief. There is sadness. There is reflection about our own lives and making the most of it.
Personally, I wanted to have the inheritance I received from my dad out of sight and out of mind as quickly as possible. And I work around money on a daily basis, knew he was dying well in advance, and had a solid financial plan.
Sometimes the best thing we can do is sit on the inheritance for 6 to 12 months. See what comes up for you and how the inheritance is affecting you.
I’ve heard of people receiving an inheritance, immediately making a big change, and regretting it. Sudden money is different than wealth you’ve accumulated.
You have time to process your own wealth growing slowly over time. When you receive $1,000,000, $2,000,000, or more as an inheritance, it opens up a world of new possibilities you may have not had before. What feels important today may feel less important a year from now.
Upgrading your home, buying a new home, buying a new car, taking time off work, retiring completely, or other life changes may not be what you really need right now.
I’m not saying that you always have to wait, but many people would benefit from that being the default option.
Imagine past moments in your life, or people you know, that were filled with heavy emotions, your family changing, and more money than you ever imagined. Was it better to make immediate decisions or pause and decide later?
Understand the Tax Consequences and What You Inherited
Taking time after receiving an inheritance also allows you to better understand exactly what you are inheriting and the tax consequences.
Depending on what type of asset you inherit, the tax consequences can be different. Let’s go through a few different areas where taxes might impact your inheritance.
Estate Taxes
Estate taxes aren’t something you’ll owe directly, but the estate of the person who died may need to pay, resulting in a smaller share for you.
The current federal estate tax exemption is $15M per person, so many estates, unless they are very large, are not subject to estate taxes; however, some states also have state estate taxes.
For example, Washington state has a $3M exemption per person and Oregon has a $1M exemption per person. The Tax Foundation has a list of states with an estate or inheritance tax.
What this means is that if someone dies with $5M, $2M would be subject to estate taxes in Washington. If that same person lived in Oregon instead, it would be $4M.
That could mean hundreds of thousands in estate taxes that need to be paid before you get your share of an inheritance.
Even if you don’t live in a state with estate taxes but you own property in a state with estate taxes, your assets in your home state may be brought into the calculation and you may owe estate taxes.
When you hear your loved one died with a certain amount, it’s important to know that you may not receive the full amount after accounting for estate taxes.
Inheritance Taxes
Five states have an inheritance tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Your relationship to the person who died, the state exemption amount, and rate will decide how much you owe in inheritance tax. Usually, the closer your relationship, such as a child, will pay less (or nothing) than siblings or a more remote relative.
For example, Pennsylvania has a 0% tax rate for a surviving spouse or a child 21 years or younger, 4.5% for direct descendants and lineal heirs, 12% to siblings, and 15% to other heirs.
If you live in a state with an inheritance tax, it’s important to understand how your inheritance will be taxed and make sure you have the funds available to pay it.
Step Up In Cost Basis
One of the benefits in our tax code is that when a person passes away, the cost basis of their investments are generally “stepped up” to the value on the date of death.
For example, if they purchased ABC Mutual Fund for $10 a share 20 years ago and it was valued at $100 at death, your new cost basis would be $100 instead of $10.
The main exception to this step up in cost basis is assets that were owned in an irrevocable trust. Assets in an irrevocable trust generally do not receive a step up in cost basis, so if you are receiving a distribution from it, the cost basis would carry over and there may be more significant tax consequences to making changes with the investments.
If a home or rental property is involved, it’s important to get an official appraisal of any home that’s inherited because you want proof of the value (and the new cost basis) for when you eventually may sell it.
Inherited IRA Taxation
If your loved one had an IRA, you have options of what to do with it. You can cash it out and take the money immediately, but you’ll owe ordinary income taxes on that distribution. If it’s a large amount, it may bump you into a much higher tax bracket.
If you are a non-spouse beneficiary, the other option is to roll it over into an Inherited IRA, take Required Minimum Distributions (RMDs) as needed (i.e. the account owner had started taking RMDs before they died), and then usually empty it by the 10th year following death. The Inherited IRA RMD rules are complicated, so you’ll need to research what rules you need to follow.
Once you know the rules, you can decide how to take distributions. For example, if you anticipate retiring in three years, you may want to distribute the minimum amount until you retire and then start larger distributions, paying special attention to which tax brackets you are filling up.
If you plan to move states, you may want to distribute the Inherited IRA sooner or it may make more sense to hold off, depending on the taxation of the state you are in versus the state in which you plan to move.
The key is to understand the taxation as ordinary income, and then you can decide how to minimize the amount of tax you pay.
Insurance Products Taxation
Inherited insurance products, such as an annuity, tend to trip people up the most.
The insurance company may send you a form allowing you to keep the annuity, annuitize it (i.e. turn it into income), exchange it into another, cash it out, or select other options.
It’s important to understand the type of annuity and the taxation.
Is it a qualified annuity? If so, you may be able to roll it into an Inherited IRA.
Is it a non-qualified annuity? Then you may pay ordinary income on the gain in the policy (i.e. the difference between the current value and what was paid into the annuity).
I often see people cash out annuities they inherit, not realize it’s taxed, and then that affects tax planning for the year.
Should I Sell or Keep My Inheritance? Time to Make a Plan
Once you understand the taxation of each piece of your inheritance, you can start to make a plan about what to keep or sell.
For example, if you inherited multiple rental properties or a primary home, do you want to move into one of them? Do you want to sell one of them? Do you want to sell all of them at once?
Selling them at death when they may get a full step up in cost basis can be helpful because you may owe no income tax on the sale.
You should think carefully about whether you really want to become a landlord. It’s not the passive income people make it out to be.
If you inherited a brokerage account and the assets received a step up in cost basis, now is your opportunity to make changes with minimal tax consequences. If your parent had an old mutual fund with historically large capital gain distributions, you could sell it. If they had a concentrated stock position, you can trim or sell it entirely. If they didn’t have enough international or emerging market diversification, you could make that change.
You can start to weigh what to do with any annuities, IRAs, farm land, Roth IRAs, cars, boats, 401(k)s, private businesses, and other assets.
I find there is often an emotional attachment to certain assets. Now is a good time to decide whether those assets fit in your own financial picture and what you want the assets to do for your life. There is nothing wrong with keeping an asset because you have an emotional attachment to it, but if it’s a large portion of your net worth, how is it jeopardizing your future?
As I mentioned at the start, you don’t have to take immediate action, but I’d encourage you to start thinking about creating a plan for your inheritance and specifically, to think about how it will serve you best going forward.
I often see people hang on to inherited assets because they become uncertain about what to do next and/or their parents were attached to it, but those assets are often not ideal for what they want to accomplish.
Should I Use An Inheritance to Pay Down Debt?
A common question is whether you should use an inheritance to pay down a debt.
As with most financial answers, “it depends!”
For people with low interest rate mortgages, such as below 4%, I’m not excited about using an inheritance to pay it down. I understand the desire to be mortgage free and the peace of mind that comes with it, and if that’s you, don’t let me stop you.
But, I would encourage you to run the numbers and figure out the difference in wealth in 10 or 20 years of investing vs. paying down that mortgage. The results may surprise you.
For people with high interest rate credit card debt or car loans, I think an inheritance can be good to pay off debt.
It depends because if you need to take a large distribution from an Inherited IRA and that is taxed at a high rate, I might space out the distributions to manage the tax brackets. It’s not an automatic cash it out and pay it off.
The same can be said for student loans or other large debts.
In general, an inheritance can meaningfully create a clean slate for many people. I’m a fan of paying down debt, but doing it smartly while managing taxes.
How Should I Use My Inheritance?
We’ve talked about how to approach an inheritance once you learn of it, but what comes next? How should you actually use it?
I’m going to give you a few ideas of ways I’ve seen an inheritance positively impact lives.
Estate Plan
When was the last time you updated your estate plan?
If you are like most people, it was probably a long time ago!
Take 30 minutes to review it, and if your life has changed, spend the money to update it. It could be the birth of a child or grandchild, divorce, marriage, moving state, or any other life changes that warrant an update.
If you don’t have an estate plan, it’s time to create one!
You received this inheritance because (hopefully) your loved one did good estate planning and didn’t leave you or their executor with a mess. Pay it forward.
Although creating or updating an estate plan is almost never fun, feels expensive, and can be time consuming, it’s a far better option than leaving a mess that takes even more time and money to clean up.
Retirement Plan
If you aren’t maximizing your 401(k), 403(b), Roth IRA, Backdoor Roth IRA, or other retirement plans, you could consider using a portion of your inheritance to make those contributions and set your future self up for more success.
You could even live off a portion of the inheritance in order to increase your retirement contributions through work. That might mean taking home a much smaller paycheck and then using the inheritance for everyday expenses. This can be a harder concept to grasp and isn’t for everybody, but it is a way to shift taxable money to tax-deferred or tax-free money that may provide you with more after-tax wealth throughout your life.
Kids or Grandkids College Planning with 529 Plans
Another option is to open and fund a 529 plan for your child or grandchildren.
These accounts are particularly powerful when the beneficiary of the 529 plan is younger. For example, if you open it when they are a few months old, you have about 18 years until they go to college. If you put in $10,000 and it grows to $25,000, you can withdraw $25,000 tax-free for qualified educational expenses.
If you wait until they are 15 years old and invest it conservatively, that $10,000 may only grow to $12,000.
When you start the 529 plan when they are young, you have time on your side. You could even superfund the 529 plan.
Charitable Giving
Another option is to use your inheritance for charitable giving either now or in the future.
The One Big Beautiful Bill Act changed the rules so that even if you aren’t itemizing deductions on your tax return, single filers can deduct up to $1,000 and married couples filing jointly can deduct up to $2,000 for charitable contributions made in cash.
Normally, giving highly appreciated stock is a great way to give to charity or by using a donor-advised fund, but because many assets receive a step up in cost basis at death, there isn’t much of a gain that you need to avoid. If you do have assets that didn’t receive a step up in cost basis, you may want to consider giving that asset (or a portion) to charity directly or using a donor-advised fund and then making grants to charity.
The other strategy you might consider is to earmark an amount for charity, wait for growth in a brokerage account, and then give highly appreciated stock.
Fun
The first four options of what to do with an inheritance is centered around things that you should do.
What about the things you want to do?
You should include using the inheritance for fun too. Use it to create memories. Use it to splurge on that thing you would never buy yourself. Use it to create joy.
My mom encouraged me to use a small portion of any inheritance on something fun. When my dad died, I used it to buy a few kitchen knives. I enjoy cooking, and my dad was a good cook. We didn’t always get along well, but I enjoyed our time in the kitchen together. The knives are a way to remember him.
I’m still a financial planner though — be cautious about how much of your inheritance you spend on fun. It’s really easy to underspend and overspend with an inheritance.
Some people cling tightly to their inheritance and “don’t want to screw it up” while others have more money than they have ever had and can see it quickly disappear.
Find the happy middle.
How Kindness Financial Planning Helps With An Inheritance
Even though I’ve worked around money for my entire career and written about how to prepare your kids for an inheritance, receiving an inheritance can still be tricky. It can come with guilt.
If you aren’t sure where to start, I can help you pause, take inventory of what you are expected to receive, understand the taxation, create a plan toward financial independence, and help you figure out how to use it to create your ideal life.
We’ll talk through the emotional side of that money and then use it in a way that fits with your values.
Along the way, we’ll figure out an investment strategy, make sure your insurance coverage is good (particularly in light of the new assets), talk through updating your estate plan, and be a resource for this next phase of your life.
You can schedule a free consultation if you are interested in figure out what to do about your inheritance.
Final Thoughts – My Question for You
Deciding what to do with an inheritance can be hard.
An inheritance may open up a new world of possibilities. You might feel overwhelmed by the sheer number of choices you have. You may be afraid of messing it up. You might feel emotionally tied to the money.
As someone who has helped people with inheritances, there is often no one right way of doing things after an inheritance. It’s important to figure out what’s important to you and where you want to go in life in order to make the most of your inheritance.
I’ll leave you with one question to act on.
What’s your first step for making the most of your inheritance?
