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INVESTING What to Do With an Inheritance: A Step-by-Step Guide 2026-02-27 · 5 min read · inheritance · windfall · estate planning

What to Do With an Inheritance: A Step-by-Step Guide

investing 2026-02-27 · 5 min read inheritance windfall estate planning inheriting money what to do with inheritance

Receiving an inheritance is often accompanied by grief and emotional complexity that makes financial decisions harder. Many people feel pressure to do something with the money right away — to invest it, pay off debt, or give some away — and that urgency can lead to costly mistakes.

The most important rule: slow down. Most financial decisions can wait. Grief cannot be rushed. Here's a practical guide for handling an inheritance wisely.

Step 1: Take 6-12 Months Before Making Major Decisions

This isn't passive advice — research consistently shows that major financial decisions made while grieving or under pressure tend to go badly. The stock market will still be there in 6 months. Real estate deals come around again. Investment opportunities you "have to act on now" are almost always scams.

Put the money somewhere safe and boring temporarily:

Do not: invest in someone's "sure thing" business deal, buy cryptocurrency under pressure, give large sums to anyone who asks (friends, family, charities, strangers), or make any irreversible financial decision in the first few months.

Step 2: Understand the Tax Situation

Inheritances are usually not taxable income to you. The estate pays estate tax (if applicable) before assets are distributed — by the time you receive the inheritance, it's typically tax-free.

Federal estate tax only applies to estates over $13.61 million (2024). The vast majority of estates are below this threshold.

State inheritance taxes are different from estate taxes and are paid by the beneficiary. Only six states have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Even in these states, spouses and direct descendants are often exempt or taxed at low rates.

Inherited retirement accounts (IRAs, 401(k)s): These are complex. Under the SECURE 2.0 Act, most non-spouse beneficiaries must empty inherited IRAs within 10 years. Withdrawals from traditional IRAs are taxable as ordinary income. This can push you into a higher tax bracket if you take large distributions. Consult a tax advisor about timing withdrawals strategically.

Inherited brokerage accounts: You receive a "stepped-up cost basis" — the value of the assets on the date of death becomes your new cost basis. This means if you sell inherited stock worth $50,000 that the deceased paid $10,000 for, you owe capital gains only on appreciation since the inheritance date, not the original $40,000 gain. This is a significant tax benefit.

Inherited real estate: Also receives stepped-up basis. If you sell quickly after inheritance, capital gains may be minimal.

Step 3: Pay Off High-Interest Debt First

If you have credit card debt, personal loans, or other debt above 7-8% interest, paying those off delivers a guaranteed "return" equal to the interest rate.

Order of payoff priority:

  1. Credit cards (20-29% APR) — always pay first
  2. Personal loans (10-20% APR) — pay next
  3. Car loans (6-10% APR) — generally worth paying off
  4. Student loans (4-8% APR) — depends on your feelings about the debt and whether loans are federal with income-based repayment options
  5. Mortgage (3-7% APR) — often better to invest than pay off a low-rate mortgage

Step 4: Build an Emergency Fund

If you don't have 3-6 months of expenses saved in accessible cash, use part of the inheritance to build this. This is foundation work — without it, the next unexpected expense puts you back in debt.

3-6 months of expenses in a high-yield savings account. Done.

Step 5: Maximize Tax-Advantaged Accounts

After emergency fund and debt, the next best use of inheritance money is often to enable more retirement savings. You can't contribute more than the IRS limits in any given year, but you can use inheritance money to "free up" your income for investing.

If you've been not maxing your Roth IRA because you needed that $7,000 for living expenses — now you can contribute the full $7,000 because the inheritance covers your living expenses for the month.

Same for 401(k): if your paycheck can be directed more aggressively to your 401(k) now that your living expenses are covered by inheritance money, do it.

Step 6: Invest Remaining Funds for Long-Term Growth

For money you won't need for 5+ years, a simple low-cost index fund portfolio is almost always the right choice. This is what Warren Buffett recommends for his wife's inheritance after he dies: 90% S&P 500 index fund, 10% short-term Treasuries.

Don't try to "do something special" with inheritance money. Many people feel pressure to invest an inheritance more wisely than their regular savings — to pick better stocks, find a financial advisor who can "really grow" the money. This usually results in higher fees and worse returns. A boring three-fund portfolio in a Vanguard, Fidelity, or Schwab account will serve you well.

Lump sum vs. dollar-cost averaging: Research shows lump-sum investing outperforms dollar-cost averaging about two-thirds of the time (because markets trend upward). But if investing a large lump sum all at once would cause you severe anxiety about a market drop, investing it over 6-12 months is fine — the performance difference is usually small, and peace of mind has value.

Step 7: Consider Real Estate (Carefully)

If you've always wanted to buy a home, a large inheritance might provide the down payment that wasn't accessible before. Real estate makes sense if:

What doesn't make sense: buying rental property or real estate investments you don't understand well because "real estate is always a good investment." Real estate is illiquid, management-intensive, and location-dependent. Many people have lost inherited money in speculative real estate purchases.

Handling Family Dynamics

Inheritances create family tension. Siblings who feel left out, relatives who ask for loans, friends who assume you "have money now" — be prepared.

You don't owe anyone an explanation of what you received or what you're doing with it. Inheritance amounts and plans are private financial information.

About family loans: Money loaned to family is money given to family. If you can afford to give it and want to, give it as a gift. If you can't afford to lose it, decline the loan.

Gifting: You can give up to $18,000 per person per year (2024 gift tax exclusion) without gift tax implications. Larger gifts use your lifetime exemption. Charitable donations reduce your taxable estate and can provide income tax deductions. But wait until you're emotionally stable before making large giving decisions.

The Summary

  1. Wait — park it safely and make no major decisions for 6-12 months
  2. Understand taxes — know what's owed and what's stepped-up basis
  3. Pay off high-interest debt first
  4. Build emergency fund if you don't have one
  5. Use it to max tax-advantaged accounts
  6. Invest the rest in boring index funds
  7. Protect yourself from family pressure and financial salespeople

An inheritance can genuinely transform your financial trajectory — but only if you handle it with care and patience. The money that compound-grows in a simple index fund portfolio for 20 years will likely be worth far more than any clever investment decision you make in the immediate aftermath of receiving it.