Receiving an inheritance is one of those financial events that can either transform your financial life or slip through your fingers if you are not careful. Whether you are expecting to inherit money someday or you have recently received one, there are some important things to know before you make any decisions.
The First Rule: Do Not Rush
The most important thing you can do when you receive an inheritance is slow down. Grief and financial decisions do not mix well. If you have just lost a loved one, give yourself time to process before you make any major financial moves with the money you have received.
Financial advisors often recommend waiting at least six months to a year before making significant decisions about an inheritance. In the meantime, park the money somewhere safe like a high yield savings account or a money market fund. It will earn interest while you take the time to think clearly.
Understand the Tax Implications First
Inherited cash is generally not taxable as income. You do not owe federal income tax on money you inherit.
Inherited retirement accounts are a different story. If you inherit a traditional IRA or 401(k), you will owe income taxes when you withdraw the money. Under current rules, most nonspouse beneficiaries must withdraw all the funds within 10 years. This can push you into a higher tax bracket if you are not strategic about the timing of your withdrawals.
Inherited investments typically receive a step up in basis, meaning the cost basis is reset to the value at the time of the original owner's death. This can eliminate a large capital gains tax bill.
Inherited real estate also typically receives a step up in basis. If you sell the property shortly after inheriting it, you may owe little to no capital gains tax.
Build the Right Team
Handling a significant inheritance is not a solo project. Depending on the size and complexity of the assets, you may need an estate attorney, a CPA or tax professional, and a financial advisor. The cost of professional guidance is almost always far less than the cost of making uninformed decisions with a large sum of money.
Integrate It Into Your Financial Plan
An inheritance is not a windfall to spend. It is an opportunity to accelerate your financial goals. Think about what matters most to you: paying off debt, building your emergency fund, maxing out retirement accounts, buying a home, or investing for the future. Make a plan for the money before it arrives in your account. An inheritance is a gift. Handle it with intention.