What to Do With Inheritance Money: Smart Strategies for Your Windfall

When you receive an inheritance, the smartest first step is to do nothing for a while. Park the money somewhere safe, give yourself time to grieve and process, then make thoughtful decisions. Rushed financial choices after losing someone often lead to regret.

An inheritance can be life-changing—but only if you handle it wisely. Studies show that many inheritances are spent within a few years, leaving people no better off than before. This guide covers smart strategies for making your inheritance last and work for you.

First Steps: Don't Rush

Before making any major financial moves:

1. Give Yourself Time

You're probably grieving. Big financial decisions shouldn't be made during emotional times. The money isn't going anywhere.

Recommended: Wait at least 3-6 months before making any major purchases or changes.

2. Park It Somewhere Safe

Put the inheritance in a safe, accessible place while you think:

• High-yield savings account
• Money market account
• Short-term Treasury bills or CDs

Don't worry about maximizing returns right now. Focus on safety and accessibility.

3. Understand What You Have

Know exactly what you inherited:

• How much cash?
• Are there ongoing tax implications?
• Is any of it tied up (like an IRA with required distributions)?
• Are there strings attached in the will?

4. Assemble Your Team

For larger inheritances ($100,000+), consider consulting:

• Financial advisor (fee-only, fiduciary)
• Tax professional (CPA or enrolled agent)
• Estate attorney (if needed)

Smart Uses for Inheritance Money

Once you've had time to think, here are the smartest ways to put your inheritance to work:

1. Pay Off High-Interest Debt

This is almost always the right first move if you have consumer debt.

Why it's smart: Paying off a credit card charging 20% APR is like earning a guaranteed 20% return—better than any investment.

Priority order:

1. Credit cards (highest interest first)
2. Personal loans
3. Car loans
4. Student loans (especially private loans)
5. Lower-interest debt

Exception: Very low-interest debt (under 4-5%) might be worth keeping if you can invest at higher returns. But being debt-free brings peace of mind that's hard to quantify.

2. Build an Emergency Fund

If you don't have one, or yours is too small, this is essential.

Target: 3-6 months of living expenses

Why it matters: An emergency fund prevents you from going into debt when unexpected expenses hit—car repairs, medical bills, job loss.

Where to keep it: High-yield savings account. Needs to be accessible but separate from your regular checking.

3. Maximize Retirement Contributions

Tax-advantaged retirement accounts are one of the best wealth-building tools available.

Options:

• 401(k): Contribute enough to get your full employer match (free money!)
• IRA/Roth IRA: $7,000 limit in 2024 ($8,000 if 50+)
• HSA: If you have a high-deductible health plan, this triple-tax-advantaged account is powerful

Why it's smart: Tax savings now (traditional) or tax-free growth forever (Roth). Compound growth over decades builds serious wealth.

4. Invest for Long-Term Growth

For money you won't need for 10+ years, investing in the market historically provides the best returns.

Simple approach:

• Low-cost index funds tracking the total stock market
• Target-date retirement funds that automatically adjust allocation
• Diversified portfolio of stocks and bonds based on your timeline

Average historical return: S&P 500 has averaged roughly 10% annually over the long term (though past performance doesn't guarantee future results).

Key principles:

• Don't try to time the market
• Diversify across asset classes
• Keep costs low (look for funds with expense ratios under 0.2%)
• Stay the course during market downturns

5. Fund Education (Yours or Your Kids')

Education is an investment in future earning potential.

For children/grandchildren:

• 529 plans: Tax-advantaged education savings
• Contributions grow tax-free if used for education
• Many states offer tax deductions for contributions

For yourself:

• Career-boosting certifications or degrees
• Skills that increase earning potential
• Be strategic—ensure the education leads to higher income

6. Make a Meaningful Down Payment on a Home

If homeownership is a goal and makes financial sense in your market, an inheritance can help.

Benefits:

• Larger down payment = lower mortgage payment
• May avoid PMI (private mortgage insurance) with 20% down
• Build equity instead of paying rent

Caution: Don't buy more house than you need just because you can. Home ownership has costs beyond the mortgage.

7. Start or Invest in a Business

If you have entrepreneurial goals, an inheritance can provide startup capital.

Smart approach:

• Start small and test your idea before going all-in
• Keep a runway (don't invest every penny)
• Consider it high-risk capital that you can afford to lose

Alternative: Invest in your existing career through professional development, networking, or creating side income.

8. Give Strategically

If giving is important to you, an inheritance is an opportunity to make an impact.

Tax-smart giving:

• Donor-advised funds let you get the tax deduction now and distribute later
• Appreciated assets can be donated to avoid capital gains
• Direct charitable contributions up to 60% of AGI are deductible

Family gifts:

• Annual gift tax exclusion: $18,000 per person in 2024
• Contributing to family members' education or medical expenses (paid directly to institutions) is unlimited

Common Inheritance Mistakes to Avoid

1. Spending It All at Once

The #1 mistake. A shopping spree or expensive vacation might feel good momentarily, but when the money is gone, it's gone.

Better approach: Budget a small percentage (5-10%) for "fun money" and be intentional with the rest.

2. Lifestyle Inflation

Upgrading your house, car, and vacations to match your new net worth. Now your expenses are higher, and the money drains faster.

Better approach: Keep living at your current level. The inheritance should improve your financial security, not your spending habits.

3. Making Emotional Decisions

Keeping the deceased's home out of sentiment when it doesn't make financial sense. Investing in a "memorial" business venture. These decisions often lead to regret.

Better approach: Separate financial decisions from emotional processing. You can honor someone's memory without making poor financial choices.

4. Lending Money to Family

"I'll pay you back" rarely happens, and resentment builds when it doesn't.

Better approach: If you want to help family financially, make it a gift with no expectation of repayment. And keep it reasonable.

5. Not Considering Taxes

Inherited IRAs, selling inherited property, and other situations can create tax bills you're not prepared for.

Better approach: Consult a tax professional before making major moves with inherited assets.

6. Keeping Everything in Cash

Fear of losing money leads some people to keep inheritances in savings accounts earning 2-3% while inflation erodes value.

Better approach: For money you won't need for years, appropriate market investments historically outpace inflation.

7. DIY Investing Without Knowledge

Putting a large inheritance into individual stocks, cryptocurrency, or other speculative investments without understanding what you're doing.

Better approach: Start with simple, diversified investments. Get educated before taking on more risk.

Tax Considerations for Inherited Money

What's Generally Not Taxed

• Cash inheritance (no federal tax owed on the inheritance itself)
• Life insurance proceeds
• Inherited property receives stepped-up basis

What May Be Taxed

• Inherited IRAs/401(k)s: Distributions are taxable income
• Inherited property gains: If you sell for more than stepped-up basis value
• Inherited income-producing assets: Income generated is taxable
• State inheritance tax: 6 states impose this (IA, KY, MD, NE, NJ, PA)

The Stepped-Up Basis Rule

When you inherit property or investments, your cost basis is the value at the date of death—not what the deceased originally paid.

Example:

• Parent bought stock for $10,000 in 1990
• Stock worth $100,000 at death
• Your basis: $100,000
• If you sell for $105,000, taxable gain is only $5,000

This is a significant tax benefit for inherited assets.

Creating a Plan

For Small Inheritances ($10,000 - $50,000)

1. Pay off high-interest debt
2. Build emergency fund to 3-6 months
3. Max out IRA contributions
4. Invest remainder in diversified portfolio

For Medium Inheritances ($50,000 - $250,000)

1. Pay off all consumer debt
2. Full emergency fund
3. Max out retirement accounts
4. Consider home down payment or additional investments
5. Consult with a fee-only financial advisor

For Large Inheritances ($250,000+)

1. Pause and take your time
2. Assemble a team: financial advisor, CPA, possibly estate attorney
3. Create a comprehensive financial plan
4. Diversify across asset classes
5. Consider estate planning for your own heirs
6. Plan for tax efficiency

Frequently Asked Questions

Should I tell people about my inheritance?

Generally, no. Money changes relationships, and not always for the better. Keep financial details private.

How much of an inheritance should I spend on "fun"?

A common guideline is 5-10% for discretionary spending. This lets you enjoy some of the inheritance while being responsible with the rest.

Should I quit my job?

Probably not. Unless the inheritance is large enough to fund your entire retirement (typically 25x annual expenses), you still need income. Plus, work provides structure, purpose, and social connections.

What if I inherit property instead of cash?

You have options: live in it, rent it, or sell it. Each has different tax and financial implications. Consider what makes sense for your life, not just sentiment.

Should I pay off my mortgage early?

It depends on your mortgage rate vs. expected investment returns. At 3-4%, you might earn more investing. At 6-7%+, paying it off provides a guaranteed "return" equal to your interest rate plus peace of mind.

Honor the Gift

An inheritance often represents a lifetime of someone else's hard work and saving. The best way to honor that gift is to use it wisely—building security for yourself and possibly future generations.

Take your time. Make thoughtful decisions. And remember: the goal isn't to preserve every dollar, but to use the inheritance in ways that genuinely improve your life.