8 Critical Steps to Take When Receiving an Inheritance

1. Understand the Inheritance

Before making any significant decisions, take time to understand the entirety of your inheritance. You will need to know the total value, and find out what assets, accounts, or properties are included. For example, perhaps you’re inheriting a 401(k), which would differ from inheriting a house.

Find out where exactly the inheritance is coming from. Are you receiving funds from a trust or from a family member’s estate? Do you need to call an insurance company to make a claim for a life insurance policy that you’re the beneficiary of?

It may be helpful to work with an attorney to review all associated legal documents you may acquire while receiving your inheritance.

2. Assess Your Current Financial Situation

Once you have a good idea of what assets you’re inheriting and approximately how much they’re worth, turn your attention to your own financial situation. You have a rare opportunity to make a big impact on your financial well-being, and it helps to make thoughtful decisions based on your current situation and future goals.

Take stock of your existing assets—house, cars, investments, valuables, etc.—and liabilities like your mortgage, car or boat loan, student loans, credit cards, etc.

If you’re currently tackling high-interest debt like personal loans or credit card debt, you may consider using your inheritance to settle those accounts. Or perhaps you’d like the freedom of having your home paid off. But say your mortgage has a 2.8% interest rate—maybe it would be more advantageous to keep paying your mortgage, and invest the inheritance instead. Considering the average annual return for the stock market over the last decade (2012 to 2021) was 14.8%, it could make sense to invest. You’ll want to consider your options carefully with a financial advisor, especially if your debt is substantial.

In general, you’ll want to think through how the inheritance will fit into your overall financial picture. It may not have one role (such as paying off debt or investing) but rather contribute to a few different elements of your plan: boost your emergency fund, save for a downpayment on your dream house, max out your 401(k) contributions for the year, etc.

3. Consider the Estate and Tax Implications

Though the ruling is set to expire in 2025, for now the Tax Cuts and Jobs Act has enacted a high exemption limit for federal estate taxes. If a loved one passes in 2023, their estate can transfer tax-free if it’s worth less than $12.92 million. That means that for most Americans, federal estate taxes won’t be an issue. For affluent families, however, preparing a tax-conscious transfer strategy is critical, considering that the top rate for federal estate tax is 40%. 

However, some states do have their own estate and inheritance taxes that your loved one’s estate or your inheritance may be subject to. Estate taxes top out at 20% in Washington and Hawaii, though in most cases the tax rate is progressive. Only Connecticut and Vermont have flat-rate estate taxes of 16% (for estates over $5 million) and 12% (for estates over $12.92 million).

The states that currently have either an estate tax, inheritance tax, or both include:  

• Connecticut
• Hawaii
• Illinois
• Iowa
• Kentucky
• Maine
• Maryland
• Massachusetts
• Minnesota
• Nebraska
• New Jersey
• New York
• Oregon
• Pennsylvania
• Rhode Island
• Vermont
• Washington
• Washington, D.C.

It’s worth noting that estate tax is the responsibility of the deceased’s estate, and is to be paid before assets are distributed to beneficiaries and heirs. Inheritance tax is the responsibility of the people inheriting the estate and is based on how much each beneficiary receives.

4. Update (or Create) Your Financial Plan

If you already have a financial plan in place, it’s always a good idea to reassess and update anytime you have a big change. This includes major events like a major salary bump, having a baby, getting married or divorced, and of course, receiving an inheritance.

If you don’t already have a plan in place, this could be the nudge you need to meet with a financial advisor and establish one for moving forward. As you determine how you’d like to incorporate your inheritance into your financial plan, consider your immediate needs—recurring financial obligations, high-interest debts, house repairs, etc.—and your long-term goals like saving for retirement. A solid financial plan will help you prioritize how you spend and save your money.

5. Emergency Fund and Contingency Planning

Imagine you lost your job tomorrow—would you have enough savings to cover your costs for the foreseeable future?

A recent study found that the median emergency savings for Americans was around $5,000, with over a third of study participants having less than that. 

With so many other financial priorities pulling people’s attention, it’s no wonder why emergency funds seem to fall on the back burner. However, having dedicated funds to addressing unexpected expenses is critical to protecting your greater financial well-being. When you have a well-stocked emergency fund, you don’t have to pull out investments early or withdraw from your 401(k). Both reduce your future retirement income and can incur penalties. 

An emergency savings is your buffer, and an incredibly important part of a well-rounded financial plan. If you haven’t built one yet, or it’s not as well-funded as you’d like it to be, this can be a great option for putting your inheritance to good use.

As a general rule of thumb, it’s recommended that you have six month’s worth of expenses or salary available in your emergency fund. If you’re self-employed or working for a start-up/early-stage company, it’s recommended that you have more.

6. Think About Your Charitable Giving and Philanthropy Goals

It’s not uncommon for people to want to give a portion of their inheritance to a meaningful organization or charity. People who may feel a little resentful of their inheritance, or otherwise guilty about receiving money, often find that putting a portion of it aside for charity helps them heal. If your family member died of a specific cause—cancer, for example—it might be meaningful to donate to organizations dedicated to finding a cure.

There are also benefits if you’re thinking about incorporating charitable giving into your financial plan after receiving an inheritance.

Not only could this be an opportunity to donate to charity that you may not otherwise have, but it could help lower your taxable income. There are many avenues to pursue, including establishing a donor-advised fund or charitable trust. You’ll want to consult a financial advisor regarding your philanthropic goals. 

7. Consider Your Own Legacy

It’s likely that throughout this process, you’ll have discovered something about how you’d like your own legacy to live on. Take the lessons you’ve learned from receiving an inheritance and put them toward establishing your comprehensive estate plan.

Working alongside an estate attorney and financial advisor, make sure your estate documents are up-to-date, including:

• Your will
• Trusts
• Beneficiary designations
• Property titles
• Insurance policies
• Medical directives
• Power of attorney

Your financial advisor can help you identify opportunities to pass on your estate in a meaningful, values-aligned, and tax-efficient manner. 

8. Seek Professional Guidance

Receiving an inheritance is an emotional experience, but it can also completely change your financial landscape. You’ll likely want to coordinate with a financial advisor, estate attorney, and tax professional to develop a holistic, tax-efficient strategy for managing this potent opportunity. 

Whether you’re preparing to receive an inheritance, are currently managing one, or are thinking about your own legacy, we’re here to help. Reach out to the Abacus team today to schedule a time to talk with one of our compassionate and experienced advisors.