Getting an Inheritance? Here’s How to Handle a Financial Windfall

If you’ve ever read a story about someone receiving a financial windfall, it’s usually about a truly life-changing amount of money. While it’s fun to daydream about winning the lottery, most windfalls are more modest.

Take inheritances, for example. According to a University of Pennsylvania analysis of Federal Reserve data, the average inheritance across all Americans – including those who did not receive one – between 2001 and 2019 was just over $12,000. However, among those who did get an inheritance, the average was $184,000 – a healthy sum, but still unlikely enough to retire on.

In other words, if you’re lucky enough to receive an inheritance, you’ll need to figure out how to fold that money into your financial plan. Depending on the form the inheritance takes, that can require some thoughtful decisions.

Inheritances often come in three primary forms: cash, real estate and investments. Here’s how you can manage each one.

What to Do with a Cash Inheritance

A cash inheritance is the most straightforward form to manage, but that doesn’t mean it’s free from challenges. Without a plan, it’s easy to spend the money quickly and lose out on long-term benefits.

What to Do:

• Pause Before Spending: Take time to process the inheritance and assess your financial goals before making any major purchases.
• Set Financial Priorities: Use the cash to strengthen your financial foundation. Consider building an emergency fund, paying off high-interest debt like credit cards or contributing to retirement savings.
• Invest Wisely: If you’ve already covered the basics, think about investing the funds for long-term growth. A diversified portfolio can help the money grow over time.

Cash inheritances offer flexibility, but the key is to use the money intentionally. A financial adviser can help you create a plan that maximizes the impact of your windfall.

Managing Inherited Real Estate

Inheriting property can feel like a gift and a burden all at once. Whether it’s a house, land or rental property, real estate often requires decisions about what to do next.

What to Do:

• Decide What You Want: Generally, your options are to sell, rent or live in the property.
  • Sell It: Selling may make sense if you don’t want to manage the property or if the costs outweigh the benefits. Fortunately, inherited real estate often benefits from a “step-up in basis,” which adjusts the home’s value to its market price at the time of inheritance. This can reduce your capital gains tax if you sell it quickly.
  • Rent It Out: Renting can provide steady income, but it also comes with responsibilities like maintenance, finding tenants and navigating tax implications. Hiring a property manager may help if you don’t want to handle these tasks yourself.
  • Live In It: If the home is fully paid off, moving in can eliminate a mortgage payment, freeing up cash for other financial goals. Just remember to budget for property taxes, insurance and maintenance.

Inherited real estate can be valuable, but it requires careful consideration. Consult a real estate or financial professional to evaluate your options.

How to Handle Inherited Investments or Retirement Accounts

Last but not least: Investments and retirement accounts like IRAs or 401(k)s are common forms of inheritance, but they come with specific rules and tax implications.

What to Do:

• Understand the Rules: If you inherit a retirement account, your options depend on your relationship to the original owner.
  • Spouses: Spouses can roll the account into their own IRA, giving them the most flexibility.
  • Non-Spouses: Most non-spouse beneficiaries must open an inherited IRA and withdraw the funds within 10 years, which may trigger taxes on traditional accounts.

Keep in mind: This is a basic overview, and there are many other factors to consider. Inheriting a retirement account is one instance where professional guidance is highly recommended to avoid penalties and ensure you don’t miss valuable opportunities. Take a deeper dive by reading this helpful article on Inherited IRA Withdrawal Rules.

• Assess Your Needs: If you inherit stocks or mutual funds, you’ll benefit from a step-up in basis, which means your tax obligation is based on the asset’s market value at the time of inheritance. You can sell the assets immediately without significant tax consequences or hold onto them for future growth.
• Plan for Taxes: Withdrawals from tax-deferred accounts like traditional IRAs are taxed as income, so work with a financial or tax advisor to minimize your tax burden and maximize growth.

Bottom Line

Receiving an inheritance is an opportunity to improve your financial future, but it requires thoughtful planning. Whether it’s cash, real estate or investments, making the right decisions can help you turn your windfall into lasting financial security.

For a step-by-step guide on how to manage your inheritance wisely, download The Inheritance Playbook: How to Make the Most of Your Windfall. This free resource provides practical tips and strategies to help you navigate taxes, investments and key financial planning decisions.