Receiving an inheritance can be both a blessing and a challenge — it may provide financial opportunities, but it also requires careful consideration and planning, often prompting the question “What should I consider after receiving an inheritance?”
Here are some key considerations for financial planning if you find yourself receiving an inheritance:
Allow yourself a grace period
Give yourself permission to pause and reflect before making any major financial decisions. Taking the time to process emotions and consider options before making significant choices can lead to better long-term outcomes.
Understand the requirements and tax implications of the inheritance
Determine exactly what you’re inheriting – cash, investments, property, or other assets. Each type of asset may have different tax implications and management requirements.
For example, inheriting an Individual Retirement Account (IRA) comes with unique rules and considerations. First, you will need to determine whether you’ve inherited a traditional IRA or a Roth IRA. The rules and tax implications differ for each – for inherited traditional IRAs, withdrawals are taxed as ordinary income, and for inherited Roth IRAs, withdrawals are tax-free. Next, you will need to determine how and when the IRS will require you to take minimum distributions from the inherited IRA. Most beneficiaries who inherited an IRA after 2020 will be required to withdraw the entire balance of the inherited IRA within ten years of the original owner’s death; however, there are several exceptions. Finally, you will need to understand the tax implications of taking distributions from an inherited IRA and how distributions will affect your taxable income. Remember, the strategy for managing an inherited IRA should be integrated into your overall financial plan.
Consult with a tax professional to understand potential tax liabilities. While inheritances other than some retirement accounts are generally not subject to income tax, there may be exceptions or future tax considerations depending on how you manage the inherited assets.
Review your financial goals
Reassess your short- and long-term financial goals. An inheritance may allow you to fast-track certain objectives or adjust your financial plan. Think about how the inheritance might impact your retirement planning, estate planning, or other long-term financial strategies.
Be cautious of lifestyle inflation, aka lifestyle creep
Resist the urge to significantly increase your spending and focus on using the inheritance to improve your financial security and achieve important life goals.
Pay off high-interest debt
Using some of the inheritance to pay off high-interest debt can provide immediate financial relief and improve your long-term financial health.
Increase savings
With more resources at your disposal, prioritize how and where to save, and consider doing one or more of the following:
- Bolster your rainy day/emergency fund – Use your inheritance to ensure you have three to six months of living expenses set aside in cash or cash equivalents for an emergency, such as job loss, major home maintenance, or illness.
- Increase retirement contributions – The old adage is “Always pay yourself first.” If you are not doing so already, make maximum contributions to your employer retirement plan, IRA, or Roth IRA.
- Open and fund a Health Savings Account (HSA) – If you are enrolled in a high-deductible health plan, open and fund an HSA. In 2024, the contribution limit is up to $8,300 (plus another $1,000 if you are 55+) in pre-tax dollars for a family. The benefit of an HSA is that you can withdraw funds from it anytime to pay for medical expenses.
- Contribute to a 529 Savings Plan – Start saving for future education expenses by contributing to your child’s 529 education savings plan.
Invest wisely
If you plan to invest your inheritance, ensure your investment strategy aligns with your risk tolerance and financial goals. Diversification is key.
Seek professional advice
Consider working with a financial advisor, tax professional, and estate planning attorney to help you make informed decisions and maximize the benefits of your inheritance while minimizing tax implications.
Resist spending in anticipation of an inheritance
A family member or close friend may divulge their intent to leave assets to you upon their death. Resist the urge to save less and spend more in anticipation of any inheritance. Circumstances can change, and your benefactor may live longer than they expect, spend down their assets/your inheritance, or they may not update their estate plan to reflect their intent to leave you their assets. Don’t count your chickens before they hatch, or you may end up harming your long-term financial health.
Remember, an inheritance can be a powerful tool for improving your financial future if managed wisely. If you’d like to discuss your specific situation and how to best integrate an inheritance into your financial plan, please don’t hesitate to reach out.