When you receive an inheritance, your knee-jerk reaction might be to spend that money on a few wish-list items.
Resist that temptation—and don’t waste the opportunity to put yourself in a stronger financial situation. You should invest that inheritance, and turn that found money into even more money.
Easily said, sure, but not so easily done. After all, you’ll need the answers to a few questions: How should you invest your financial windfall? Should you pay off student or personal loans? Do you need a tax advisor?
I’ll answer all of these questions (and more) below.
Let’s talk about how to invest an inheritance. People at different financial stages of life have varying investment needs, so I’ll look at what’s logical for different situations, explain the best investments to make with a sudden infusion of cash, discuss how to handle non-liquid assets, and much more.
What Is an Inheritance?
An inheritance is the financial assets a person passes on to a legal heir upon their death. Those assets may include cash or investments in a brokerage account, or more tangible stores of wealth—alternative assets such as real estate or precious metals.
Inheritances range widely in value, and they might go to one heir or several. The deceased person’s will states who receives what. In the absence of a will, a court will choose an administrator to divide the assets in accordance with state laws.
The heir or named beneficiary of an inheritance can choose how to spend any money they receive, unless provisions in the will dictate otherwise.
What to Do With an Inheritance: 2 Things to Do BEFORE You Invest
It might be tempting to go on a spending spree, but it’s important to prepare for your financial future first. A major cash or asset influx is an opportunity to improve your net worth and long-term financial independence.
While we suggest investing most of your windfall, there are two other smart money moves to make before you put your newfound wealth to work for you.
1. Pay off High-Interest Debt
High-interest debt, such as the balance on a card debt, can be challenging to tame because the balance can grow so quickly with interest. And in many cases, the rate at which high-interest debt grows may be greater than the rate you could reasonably grow your money through investments. Thus, paying off high-interest debt should be the very first financial move you make with inheritance money.
“What percentage interest rate is considered ‘high interest’?” Good question! There’s no fixed number, but generally, a high rate is generally considered to be an interest rate that’s above what “good debt” charges. Good debt generally refers to loans you take out to acquire something of lasting, tangible value, like a home or a college education (aka mortgages or student loans).
For example, mortgage interest rates for a 30-year fixed mortgage currently hover around 7%. Comparatively, the average interest rate for a credit card is much higher—around 20% right now!
One way to decide what debt to pay off is to consider how else you could invest the money. If the expected rate of return on an investment is lower than the rate you pay on the debt, you should probably pay off the debt first. For instance, over the very long term, the stock market returns roughly 10% on average. So if you’re paying 20% annually on your credit card balance, you’re much better off eliminating that debt first. Conversely, if you have a mortgage with a 4% rate, you should consider using that inheritance money to invest in stocks, as you’ll likely earn more over time than what you’re paying in interest.
2. Create an Emergency Fund
Life is unpredictable; you never know when a costly emergency will strike, and a costly emergency can financially cripple you. Consider this: In the U.S., medical debt is the No. 1 cause of bankruptcy. Even with “good” insurance, a medical emergency can drain far more of your own money than you expected.
An emergency fund helps make ends meet if you lose your job or get hit with a big, unexpected expense. Personal finance experts commonly recommend that you save enough to cover three to six months’ worth of regular living expenses, such as your monthly rent or mortgage payment, grocery bills, and utilities.
To determine that number, build a budget, then track your spending to see how much you spend each month on true essentials over the course of three to six months. This number will differ greatly depending on your lifestyle and family size. But the point is to see what you truly need, versus what you spend on wants, and make sure you can cover the needs if you suffer a financial hardship.
In general, it’s best to use a fairly liquid account, such as a high-yield savings account or money market account, for your emergency fund.
How to Invest an Inheritance
If you inherit cash, consider both your current and long-term financial needs. If you don’t need to pay off high-interest debt or build an emergency fund (or if you do, but you have money left over), you’ll want to consider putting that money to work by investing it.
Before I go over how to invest that money, here’s an important thing to remember: There is no one-size-fits-all suggestion. Your personal risk tolerance will have a lot of say in how you invest your inheritance. What’s right for you might not be right for your neighbor, and vice versa.
In no particular order, here are some of the best ways to invest an inheritance:
1. Buy a House
A house is a functional investment. You’ll no longer need to pay ever-increasing rent to a landlord. And unlike stocks or other investments you own but never see, you use your home every day.
There’s no guarantee your house will increase in value over the long term, but historically speaking, there’s an awfully good chance. And depending on where you live, that increase could be substantial.
Buying a home with the proceeds of an inheritance, rather than taking out a mortgage, can save you a lot of money. Not only do you avoid mortgage interest; you might also be able to skip appraisal fees, origination fees, and other closing costs.
Additionally, paying with cash makes you a more competitive buyer, because the seller doesn’t have to worry about your financing falling through after accepting your offer. In a bidding war, sellers often choose cash buyers over those who are willing to pay more but need a mortgage.
2. Invest in Taxable Brokerage Accounts
A quick and effective way to invest that inheritance money is to put it into a self-directed taxable brokerage account. This is a standard investment account that allows you to put your money to work in a wide range of publicly traded vehicles. As the name suggests, these accounts don’t enjoy any tax advantages—you’ll be responsible for capital gains and other taxes every year. But they also typically allow you to own more types of investments than any other account.
A few of the most popular investments to make within a brokerage account:
Stocks are tiny slices of ownership in publicly traded companies that allow you to share in a company’s growth and profits.
While some investors focus on swing or day trading, most people are best off buying big, stable companies they can hold for the long-term. Some basic strategies to consider are:
- Growth stocks: Companies expected to grow faster than their peers.
- Value stocks: Companies that are considered underappreciated, and whose share prices are expected to improve once other investors realize their true value.
- Dividend stocks: Companies that make cash distributions to investors, providing an additional source of return.
Bonds are debt issued by an entity (like, say, the federal government or a corporation). When you buy a bond, that entity is making a promise to pay back the principal (what you paid for the bond) as well as interest. That interest is typically the major source of returns from bonds. A few common types of bonds:
- Treasuries: U.S. federal debt. It’s considered some of the safest debt in the world, and interest from Treasuries is tax-exempt at the state and local levels.
- Corporate bonds: These are bonds issued by companies. Most corporate debt is considered less secure than Treasuries, but you’re typically paid more in interest to compensate you for that risk. They offer no tax exemptions, however.
- Municipal bonds: Government debt issued at state, county, city, and other local levels. These are tax-free at the federal level. They’re also free of state tax if you live in the state where the bond was issued, and free of local tax if you reside in the municipality that issued the bond.
A mutual fund is a type of pooled investment—investors give money to the fund company, and management invests that money in certain stocks, bonds, or other investments based on certain parameters. (For instance, a mutual fund might invest all of its money in stocks of small companies, or in high-quality corporate debt.) This allows an investor to get access to dozens, hundreds, even thousands of investments—and thus defraying quite a bit of risk—within a single instrument.
This convenience isn’t free, of course. Investors pay certain fees for these services—an “expense ratio” that’s automatically taken out of performance is typical, though certain sales fees can be taken out of the initial investment or from a lump sum that’s being withdrawn. Most mutual funds are actively managed, meaning one or more humans make investment decisions—and those managers must be paid. Some mutual funds are “indexed,” which means the fund merely tracks a rules-based index (like the S&P 500); these funds also charge fees, but they tend to be less than their actively managed counterparts.
Exchange-traded funds (ETFs)
An exchange-traded fund (ETF) is similar to a mutual fund, but it has a few key differences.
For one, ETFs trade on an exchange like stocks do; that differs from mutual funds, which only trade once per day (at the end of the trading day). They also only have an expense ratio; no other sales fees are ever charged. They operate more tax-efficiently than mutual funds. And they tend to be cheaper than mutual funds—largely (but not entirely) because the majority of ETFs are index funds.
3. Max Out Retirement Accounts
Want to get more bang for your buck than investing in a taxable account? Consider maxing out your retirement savings accounts, which enjoy special tax advantages (and thus help your money grow even faster).
With a tax-deferred retirement plan, such as a 401(k) or traditional individual retirement account (IRA), you contribute with pre-tax dollars, and investments are allowed to grow tax-free; you only ever pay taxes once you make withdrawals in retirement. A few other accounts, including Roth IRAs and Roth 401(k)s, allow you to contribute money after taxes have been taken out—but again, the money grows tax-free, and you don’t have to pay a cent in tax once you withdraw your earnings in retirement. In all cases, though, these accounts have contribution limits.
If you want to max out workplace accounts like a 401(k), you’d basically divert more of your paycheck into the account, then use your inheritance to replace some of your earnings so you can pay your current living expenses. If you want to max out personal retirement accounts like an IRA or Roth IRA, you’d simply invest that money in your account, up to the annual IRA contribution limit.
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4. Establish a 529 Plan
If you have a child who is likely to attend college, you can also use your inheritance to save up for educational expenses.
A 529 plan, which is administered by a state government, is a tax-advantaged account designed specifically for education savings. Earnings in a 529 account grows tax-free, and you won’t pay any taxes upon withdrawal, either, as long as those earnings are used to pay for qualified education expenses.
Additionally, more than 30 states and the District of Columbia provide a state tax break when you make contributions to your in-state 529 plan.
5. Invest in Real Estate
Real estate is an “alternative asset” (an investment other than stocks and bonds) that helps you diversify your portfolio and hedge against inflation.
Real estate investments vary widely. For instance, you could choose to buy a rental property. Of course, if you didn’t want to find tenants, perform maintenance, and deal with complex financials, you could also invest in physical real estate through online real estate investment platforms, such as Fundrise and EquityMultiple.
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You can even invest in real estate through a typical brokerage account by purchasing shares of real estate investment trusts (REITs). A REIT is a company that owns (and usually operates) income-producing real estate, and it enjoys special tax benefits—in exchange for distributing 90% or more of their taxable income back to shareholders as dividends.
6. Invest in Other Alternatives
Alternative assets run the gamut, from more commonly known assets like real estate, gold, and private equity, to lesser known ones like wine, art, and even shoes. These assets tend to act independently of stock and bond markets, so it’s possible for them to rise in value even when those markets are down. They can also be more lucrative than traditional investments—but those higher returns can come with higher risk.
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What to Do If You Inherit Non-Liquid Assets
Not all inheritances come as convenient, liquid cash. Some are less liquid assets, such as property or collectibles. Figuring out what to do with them is trickier than choosing how to allocate a cash windfall.
What to Do With Investments You Inherit
When you inherit a brokerage account, you’ll need to contact the account’s custodian to get it transferred into your name. Then, you have to decide what to do with the investments in the account.
It can be tempting to liquidate everything. This can be a wise option if you consider yourself a better investor than the person who bequeathed you the inherited account, as you might be able to put the funds to better use.
Perhaps you inherited very conservative investments from an older individual but want to invest in riskier assets because you are younger. You might also have debt that could be paid off with the proceeds of selling those conservative investments.
But in some situations, it’s better to leave the investment mix alone and let the account grow. By standing pat, you don’t have to worry about the potential tax implications that could come with selling. Or, the deceased person may have chosen investments that are performing well.
This decision isn’t all-or-nothing, either. You can liquidate some investments and keep others, depending on your circumstances, your financial goals, and your risk tolerance.
If you’ve inherited an IRA, consult a certified public accountant to make sure you do everything in accordance with the relevant laws governing retirement accounts. Those rules vary depending on the deceased person’s age, your age, your relationship with the deceased, and any required minimum distributions.
How to Handle Inherited Real Estate Investments
Real estate is a common asset to inherit. Let’s consider a scenario where you inherit a deceased family member’s house. Some of your options would include:
You aren’t under any obligation to keep a house you don’t want, especially if it’s a seller’s market and you could put the proceeds of the sale to better work through other investments. The cash you receive could be used to pay off debts or make a range of productive investments. Also, you only owe taxes if you sell the house for more than it was worth when you inherited it. Suppose you inherited a home valued at $250,000 and sold it for $300,000. You would pay taxes on $50,000. (The tricky part can be determining a fair market value for the property at the time of the decedent’s death.)
Another option is to rent out the newly acquired property. This may provide you with a consistent cash flow, diversify your monthly income streams, and grow your long-term wealth. One downside is that you are responsible for maintenance, property taxes, and the other costs of homeownership. Depending on location, it can be difficult to rent out a home as a short-term vacation unit, because local laws often limit that option. If renting out the home as a long-term residential property, you could end up with tenants who don’t pay regularly or other headaches that come with being a landlord. And the taxes can get complicated.
If you don’t already have a home and live (or could live) in the area, moving in might be the best option. You wouldn’t have to save for a down payment and take on a mortgage, letting you invest more money in other ways. If you already have a home, the one you inherited might be larger or in a better area, allowing you to sell your current house. On the downside, if you’re currently renting, you’ll become responsible for the home’s upkeep and taxes. Taking on those costs is a personal financial decision.
Consider Meeting With a Financial Advisor
The complexity of handling inheritances can vary significantly.
Consider using a financial advisor if you expect you’ll need to pay federal estate taxes, need to split assets among many family members, have inherited an IRA, or face other complicated situations.
A financial planner can help if you are unsure how to proceed with your inheritance and give you personalized investment advice. A good financial advisor can also identify helpful tax breaks.
You might also want to talk to an estate planning attorney, depending on what assets you inherited and their value.
Examples of How to Invest an Inheritance
What to Do With a $50,000 Inheritance
Your top priorities should always be to eliminate high-interest debt and make sure your rainy day fund is topped up. Then, if you aren’t maxing out contributions to your retirement accounts, this is an excellent way to allocate any remaining money. You can also use inheritance funds towards a down payment if you don’t own a home.
What to Do With a $100,000 Inheritance
Let’s say you have no high-interest debt, already have a solid emergency account, own a home, and max out your retirement savings. For anyone with a child likely to go to college, funding a 529 college savings account is a wise move for the tax breaks. Plus, your child will graduate with little or no debt. Another excellent option is to invest in stocks, bonds, real estate or alternative assets through a brokerage account.
What to Do With a $200,000 Inheritance
At this level, your options become pretty numerous. In many low-cost areas, you could buy a home with cash or make a sizable down payment. If you were renting, this could be a functional investment that both provides you with a place to live and the potential for long-term price appreciation. For more ideas, consider two hypothetical situations of people in different financial circumstances who inherit $200,000.
In Scenario 1, the beneficiary is single, just a year out of college, has some credit card debt, no kids, and rents an apartment. A smart inheritance breakdown might look like this:
- Pay off credit card debt: $5,000
- Create an emergency savings account: $15,000
- Home down payment: $60,000
- Max out 401(k): $22,500 of annual income (based on 2023 limits)
- Buy a car: $25,500
- Invest the remainder: $72,000
In Scenario 2, the beneficiary is married, has two kids, has no debt except a mortgage, and is happy with their current home. The inheritance might be allocated like this:
- Max out 401(k) for self and spouse: $45,000 (if both work, based on 2023 limits)
- 529 plan funding for both children: $40,000
- Pay off mortgage: $60,000
- Invest the remainder: $55,000
The more you inherit, the wiser it is to talk to a certified financial planner and figure out how to make the best use of the money you’ve inherited.
Do You Pay Taxes on an Inheritance?
While there isn’t a federal inheritance tax, some people must pay federal estate taxes. The 2024 estate tax exemption is $13.61 million for single filers and $27.22 million for married couples. (Also note that some states have either inheritance taxes or estate taxes, and some of the thresholds that trigger them are lower than the federal estate tax.)
If the value of the estate you inherit is less than the federal estate exemption (as is the case for most people), you don’t have to pay federal taxes on it.
When people inherit an estate worth over that amount, the value is taxed on a sliding scale from 18% to 40%, depending on the estate’s value.
Note that while inheritances aren’t considered income for tax purposes, any subsequent earnings on the inherited assets are taxed, unless they are from a tax-free source.
For example, if you inherited stocks in a standard brokerage account and they rise in value after you acquire them, your taxable capital gain is calculated by subtracting their price when you received them from the price at which you sold them.
The price the decedent paid is irrelevant to your tax liability calculation. In fact, if the stock falls in value after you inherit it and then you sell, you can deduct that capital loss from any other investment gains you may have.