How To Make the Most of Your Inheritance

Grief can be mentally, emotionally and physically exhausting, which can make administrative tasks more challenging and affect your ability to make sound decisions. Before making any decisions about your inheritance, you should take time to mourn and care for yourself and your loved ones.

“The very first thing [the recipient of an inheritance should] do is separate the grieving process from their administrative and management process,” says Mark Shepherd, a Certified Financial Planner™ professional and Founder/CEO of Shepherd Financial Partners in Winchester, Massachusetts. “We find, unfortunately, generally too great of a mix between the two and try to give our clients the opportunity to properly grieve, then come back to look at the administration to make great decisions.”

Once you’ve had time to grieve, you’ll want to define your priorities, rank them based on your needs and wants, then go through the proper channels to reach your goals.

Define Your Priorities

“The first order of business is to do your own personal financial plan — whiteboard how you think it should look and what your goals are,” says Shepherd.

How you use your inheritance will vary depending on how much progress you’ve already made on goals like paying down debt and saving for retirement.

Before diving into any details, decide what percentage of your inheritance you want to dedicate to each of four major categories:

• Paying off debts
• Putting money into savings
• Setting aside funds for others
• Spending on other things

Once you’ve split your inheritance into these basic categories, making individual decisions about your assets will be a lot easier.

How much you dedicate to each category is completely up to you, but most experts agree that you should prioritize debt first, then savings and investment, then funds you plan to give away and then spend whatever is left.

Receiving an inheritance can be an overwhelming experience from just a financial perspective. Complicating the situation is that the beneficiary is probably going through various stages of grief and may not be in a position to make sound financial decisions. But the rules of receiving an inheritance, particularly Individual Retirement Accounts (IRAs) have become much more complicated in the last few years. Consulting a financial advisor acting in a fiduciary capacity can help guide you to make the most appropriate decision. 

Toby Walters, CFA®, CFP®Senior Financial Analyst

Toby Walters, CFA®, CFP® is a senior financial analyst with over 25 years of experience in financial research. His knowledge spans researching and analyzing financial data to developing a one-of-a-kind viewpoint on money-related topics.

Settle Your Debts

Your first priority in distributing your inheritance should be eliminating any significant debts. This doesn’t mean you should automatically sink your entire endowment into paying off outstanding balances, but if you have any debts that accrue interest at a rate faster than your interest-bearing accounts and investments, your money will be best spent on closing those accounts.

How To Do It

To figure out which debts you want to settle with your inheritance, look at all of your outstanding balances and evaluate whether they’re considered high- or low-priority.

Common high-priority debts:

• Auto loans
• Credit card debt
• Personal loans taken for nonessential purchases
• Unsubsidized student loans
• Medical debt
• Payday loans

These debts often have high APRs, which makes them very costly and difficult to manage.

On the other hand, there are categories of “good” debt that you should keep open. These debts usually have lower APRs or help balance your credit mix, which bolsters your credit score.

Common low-priority debts:

• Subsidized student loans
• Mortgage loans
• Zero-interest loans
• Small business loans

If a debt has an interest rate that’s lower than your investment portfolio’s average return, it makes more sense to keep the debt and put your money toward saving strategically. Similarly, mortgage debt is usually a low priority because real estate often appreciates, which can offset the cost of interest.

Save Strategically

Once you’ve settled high-priority debts, your next objective should be to find ways for your money to earn you more by accruing interest, appreciating in value or qualifying you for tax advantages.

How To Do It

Just like you prioritized your debts by most to least expensive, you’ll want to prioritize your savings in the same way.

The most important savings accounts to maintain are an emergency fund and your retirement fund. If you’re low on emergency funds, use this opportunity to replenish them. If you got a late start on saving for retirement, your inheritance can help you catch up.

Prioritize tax-advantaged accounts like your 401(k) and traditional and Roth IRAs. Once you’ve maxed out these accounts, consider expanding your retirement savings with growth-oriented investments, such as stock funds and real estate investment trusts, and income-oriented investments, such as bond funds and fixed annuities.

Diversifying your holdings helps mitigate risk and protect your savings against economic downturns.

First, invest in products that offer the highest returns at the lowest risk.

Lower-Risk Investment Options

• Money market accounts
• Fixed annuities
• High-yield savings accounts
• Certificates of deposit (CDs)
• Investment grade bond funds

Then, diversify with riskier investments that offer even higher returns. 

Higher-Risk Investment Options

• Variable annuities
• Commodities
• Real estate investment trusts (REITS)
• Stock funds     
• Non-investment grade bond funds

Set Aside Funds for Others

Choosing to donate or bequeath your assets to others is a personal choice that depends on whether you have dependents, your relationships with your loved ones and your personal connections to charities and religious organizations.

Some people choose not to leave anything behind. If you are planning to set aside funds, it’s important to do so in a strategic manner.

How To Do It

You’ll want to establish different types of funds, depending on your beneficiaries. Two common vehicles for amassing funds for heirs are trusts and annuities.

There are dozens of different types of trusts, but each structure is characterized by a trustor (the person bequeathing the funds), a trustee (the person responsible for dispersing and managing the funds) and a beneficiary (the person receiving the funds). The drawback of a trust is that it requires an individual to be responsible for fund disbursements. Oftentimes, this is not an issue. However, in some situations, it can result in interpersonal conflicts with the account’s beneficiaries and their family members.

An alternative way to pass funds onto your heirs is to purchase an annuity. Like a trust, an annuity disburses payments to beneficiaries in increments. However, annuity payments are made by insurance companies, not individuals, which is a feature that eliminates the potential for interpersonal conflict.

Save for College

If you decide you want to set aside some of your inheritance for a loved one’s future college tuition, you should open an account designed specifically to save for educational expenses. These accounts are tax-advantaged. Some provide tax deductions, and some allow for tax-deferred or tax-exempt growth of investments.

The four most common college savings accounts are 529s, Coverdell Educational Savings Accounts, UGMA accounts and UTMA accounts.

Donate to a Nonprofit

If you want to donate part of your inheritance to charity, you can do it directly or you can establish a donor-advised fund. A donor-advised fund is a charitable investment account that receives your irrevocable contributions, invests them in a tax-free manner and grants them to handpicked charities on a timetable established by you.

The primary advantages of donating via a donor-advised fund relate to flexibility. Specifically, these vehicles give you the flexibility to donate over time and to gift a broader array of assets than other charitable forums allow. 

Spend What’s Left

A final way to get value from an inheritance is to simply spend a portion of it on something that brings you and your family comfort and joy. This does not have to be a big spend. Oftentimes, a small, sentimental gesture can have a powerful, long-lasting emotional benefit.

How To Do It

Unlike the first three strategies on our list, no authority is needed to determine how to spend some of the inheritance. You are the expert in this space and you will know the best way to proceed. That said, read on for some inspirational ideas.

Honor Your Loved One’s Legacy

There are many ways you can honor your loved one with a long-lasting token of their memory. You can organize a private dedication or you can opt to set aside some funds to sponsor or donate to a cause or organization they cared about.

Here are some options you can consider when deciding how to memorialize your benefactor:

• Adopt a bench in your loved one’s favorite park.
• Name a star after your loved one.
• Work with your community to commission a mural.
• Sponsor a guide dog.
• Dedicate a pew in your loved one’s church.
• Adopt a room in your local Ronald McDonald house.
• Fund a room at your local homeless shelter.
• Sponsor a child in need.
• Put together an online memorial page.

Whatever way you decide to memorialize your loved one, be sure to check the legitimacy of charitable causes of interest before making a donation.

Share an Experience With Family

When you use part of your inheritance for family activities, you give your loved one the chance to provide one final gift to those they left behind. Finding opportunities to create new happy memories lets your family move toward closure in a way that’s positive and peaceful.

• Take a family trip to your loved one’s birthplace.
• Host a family reunion.
• Plan a day of service for your family to participate in a cause your loved one cared about.
• Try out one of your loved one’s favorite hobbies together.

Anything that brings your family together in memory of a loved one is a wonderful way to honor their legacy.

Relax and Recover

End-of-life care, events and rituals are exhausting. After weeks or even months of bereavement ceremonies and customs, you could probably benefit from an opportunity to recuperate.

• Sleep hygiene is incredibly important for coping with grief, so consider upgrading your bedroom to help ensure your mind and body can rest.
• Enroll in a yoga class. Science shows that yoga practice helps individuals process loss and foster a closer relationship with loved ones who have passed.
• Take a grief retreat to connect with others experiencing similar loss or to practice coping mechanisms like mindfulness, meditation and exercise.
• Grief affects our cognitive function, making basic tasks more challenging. Consider hiring additional help for a few weeks or months. Extend the babysitter’s hours, splurge on a home meal delivery service or have the house professionally cleaned to lighten your load while you recoup.
• Adopt a pet! Pets are so effective in helping humans cope with grief that funeral homes have begun keeping trained therapy dogs onsite.

Self-care is complicated, especially in grief, so setting aside some of your budget for things that alleviate emotional challenges and help you nurture yourself is a great idea.

What About Taxes?

In many cases, an inheritance is subject to compliance laws and could be subject to federal, state and local taxes. Thoughtfully managing your inheritance is the key to maximizing potential tax benefits and avoiding withdrawal penalties.

• IRAs and Roth IRAs have specific requirements for beneficiaries that vary depending on the relationship to the original owner and the age of the original owner when they passed.
• Bonds may or may not be taxable, depending on whether your loved one already paid taxes on the bonds’ earned interest.
• Stocks are not subject to taxes unless the beneficiary chooses to sell, at which point the profits are subject to capital gains taxes.

Besides income taxes, there are also a number of inheritance-specific taxes that may or may not apply to your endowment.

• Estate tax: A maximum 40% tax that applies to inheritances in excess of $12.92 million; individual states also have estate tax thresholds and rates that may be different.
• Inheritance tax: A state-level tax applicable in Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.
• Capital gains tax: A tax that applies to the profit generated on any inherited capital assets sold for more than their market value on the donor’s date of death.

Conducting the research necessary to manage your inheritance can be challenging, but the peace of mind that comes from prudently handling money received from a deceased loved one is worth it.

Frequently Asked Questions About Inheritance

Editor Bianca Dagostino contributed to this article.