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You’ve Received an Inheritance. Now What?

April 9, 2024

An inheritance, particularly a large infusion of cash or assets, can be overwhelming. This article explains why it’s important to work with financial and legal advisors to avoid “emotional” decisions. With long-term goals in mind, you can put newfound wealth to work.

Even if you’ve long expected it, receiving an inheritance can be somewhat disorienting — particularly if it’s a large windfall that could alter your current standard of living. Fortunately, there are advisors (including CPAs, attorneys and financial planners) who can help you avoid making “emotional” decisions and, depending on your current situation and financial goals, put your newfound wealth to work.

Pause For Breath

First off, if your loved one’s estate is still being administered, don’t spend your inheritance — or make any financial commitments based on it. Wait until your life has gone back to “normal” and you know what the net proceeds will be. Once all fees and any taxes are accounted for, the final settlement may be less than you initially expected. If you’re receiving your inheritance through a trust, talk with the trustee, familiarize yourself with the trust’s terms, and be sure you understand the timing and amount of distributions and any conditions that must be satisfied to receive them.

Although an inheritance generally isn’t subject to income tax, depending on the types of assets you inherit, they may affect your tax situation going forward. For example, certain income-producing assets — such as real estate, an investment portfolio or a retirement plan — may increase (perhaps substantially) your taxable income.

Retirement, Estate and Insurance Planning

If you inherit an IRA or a qualified retirement plan account, such as a 401(k) plan, make sure you understand rules regarding distribution of those funds. The treatment of an inherited IRA or qualified retirement plan, such as a 401(k), depends in part on your relationship to the deceased.

For example, if you inherit an IRA or 401(k) from your spouse, you can liquidate the account penalty-free, and pay tax due as ordinary income. Or you can roll the funds over into your own IRA and allow them to continue growing tax-deferred (tax-free for a Roth account) until you withdraw the funds. But the rules can be complicated, so be sure to consult with your advisor. In general, non-spouse heirs have fewer options than spouses. For instance, they must now take total payouts from an inherited 401(k) account within 10 years of the death of the account’s original owner.

Depending on the size of your inheritance, additional money may also affect your estate plan. If it increases the value of your estate to a point where estate taxes become a concern, talk with your advisor about strategies for reducing those taxes and preserving wealth.

You may further need to adjust your insurance coverage. For example, if you inherit real estate or valuable personal property such as artwork or jewelry, adjust the property and casualty coverage for them. And because greater wealth makes you a more attractive target for lawsuits, consider purchasing an umbrella liability policy or increasing the coverage of an existing policy. Finally, you may wish to buy additional life insurance.

Integrate Your Windfall

Studies have found that leaving an inheritance separate from other assets can encourage impulsive, unplanned spending. So aim to integrate inherited assets into your overall financial plan. If you have credit card or other high-interest debt or lack an emergency fund, use your inheritance to pay off (or build up) those first. The rest should be available, along with your other assets, for funding retirement, college expenses for children, travel, real estate or other financial goals.

In addition, it’s important to keep your job — at least initially. Most windfalls aren’t large enough to see an heir all the way through retirement. Until you have a handle on the amount available after taxes and debts are paid, and you’ve identified solid financial goals, you won’t know if you can stop working. It helps to think about where you’d like to be in five, 10 or 20 years. Consider revising your financial plan to help you move toward goals — whether that means retiring early, starting a business or something else.

Finally, be careful if friends, family members and charities ask for money. The ability to support loved ones and worthwhile causes is a real benefit of a windfall. At the same time, if you accede to every request, you’ll quickly deplete your funds. Also, before you donate to a charity, ensure it’s legitimate by checking its tax-exempt status with the IRS and reviewing its profile on nonprofit charity evaluation sites such as CharityWatch and Charity Navigator.

Myriad Issues

Of course, your initial reaction to receiving an inheritance likely will be grief for the lost loved one. But when you come up for air, schedule an appointment as soon as possible with a trusted professional advisor who can help you deal with the myriad estate, tax and financial planning issues that are likely to arise.