At some point in your life, you may find yourself the recipient of an inheritance from a departed loved-one. While you may feel gratitude for the gift they left you and the opportunities it provides, receiving an inheritance can be a surprisingly disorienting experience. Life does not immediately become worry-free even in the case of a large windfall. And there is so much to think about – where to deposit it, how to spend or invest it, what it means for your future. Here’s how to handle the transition thoughtfully and thankfully.
Phase 1: Take a Breath
Perhaps counterintuitively, your best first step is to simply pause and take a deep breath. This is a time when emotions run high, and the path forward is not as straightforward as you might expect. Take heart. This experience is a common one.
Indeed, recipients of an inheritance often find themselves overcome by unexpectedly mixed emotions that may include gratitude, relief, guilt, fear, urgency, responsibility, and confusion. That jumble of feelings may land against a backdrop of grief at your recent loss. In parallel, unwelcome counsel from (probably) well-meaning family and friends could exacerbate the feeling of overwhelm. The contrast between reality and expectations can have you wondering if you were better off without this gift!
Maybe this feels like a “first world problem.” That doesn’t mean you should berate yourself if you don’t immediately feel grateful and infused with a sense of purpose for this money. Instead, a thoughtful, measured approach is your best bet.
One note – Before hitting the pause button for too long, there is one important action item. If your inheritance came in the form of a paper check, be sure to deposit the check promptly, even if the funds go into a humble savings account for the time being.
Phase 2: Take an Inventory
Once you have taken time to process emotions around the inheritance and consider your options, you are ready to account for the change to your financial picture. That starts with taking an inventory.
This involves understanding the components of your inheritance. If all the money was in the form of a check that is now deposited, this step is a piece of cake. However, there are many other forms an inheritance could take, each with its own set of parameters and constraints. Familiarizing yourself with these is time well-spent.
For example, those inheriting an IRA might be subject to the IRS’s 10-year rule, which imposes stiff tax penalties on certain beneficiaries who fail to withdraw the full balance of the account within a decade of the original owner’s passing. There are many ways to fulfill this distribution requirement, some of which will suit you better than others.
Other tax-advantaged accounts like 401(k)s, 529s, and Health Savings Accounts have their own unique distribution requirements and tax consequences. On the other hand, if you’ve received a non-retirement portfolio, you may enjoy a step-up in basis on appreciated assets, so near-term taxes are less of a concern.
For any investment account, you will want to research the underlying securities and any associated costs to help determine next steps. For example, you may want to consolidate the inherited assets into your preexisting accounts. You may also wish to reallocate your investment profile given your new overall level of risk. If you inherited cash, you will want to determine whether the cash should serve short-term needs or if it could be working harder elsewhere. If your loved one had an investment advisor, that advisor may be able to help you think through these details. If you have an advisor of your own, this may be something they can help with.
Of course, you may not have immediate access to your entire inheritance. Proceeds from a family home or a business pending sale might be distributed when sold or over time. Assets jointly held with others or in trust may be subject to restrictions that limit your options. If this is the case, you will want to get clear on the timing of expected future inflows and their tax implications.
Another factor to consider is the concept of Separate Property. Typically, in California, anything that a spouse inherits is their own separate property. An inherited IRA can only be in one individual’s name, so the potential to inadvertently commingle inherited retirement assets is easily side-stepped. However, in the case of a non-retirement inheritance, it is prudent to keep its separate property status clear and easy to track. This might mean not depositing a check into a joint checking account, nor transferring inherited stock or mutual fund shares into a joint investment account. This does not mean you cannot withdraw your inheritance (or pieces of it) and spend it for the benefit of both you and your spouse, but until it is spent, it is wise to keep it in an account that accurately reflects its status as separate property.
This is just a sampling of the many moving parts you might encounter when sizing up your newfound assets. It can be a lot to tackle – not something everyone is equipped or inclined to do. Engaging with an investment advisor or financial planner can help streamline this phase and provide guidance.
Phase 3: Build a Plan
Now you are ready to devise a plan. Like any financial review, you will want to begin with updating your goals. Depending on your prior financial status and the size of the inheritance, this could translate to anything from minor tweak to total transformation.
A large windfall could mean all of your goals are potentially funded by this single event. This sudden financial empowerment could cause you to feel like the efforts you made up until this point to secure your own financial future are suddenly moot. This is not an uncommon feeling, but it is one that can be addressed by giving yourself time to revisit your goals and make thoughtful plans for your finances. Perhaps you have a new-found desire to support a non-profit you feel passionate about. Or perhaps you would like to scale back your work hours to spend more time with family and friends. It can take time to see the inheritance as your money and come to terms with its impact.
On the other hand, if your inheritance is not as large, your focus will likely revolve around how to allocate resources across potentially competing goals: Eliminate credit card debt, or bolster your emergency fund? Pay off your mortgage, or fund a college savings plan? Take a once-in-a-lifetime vacation, or launch a business? Take a sabbatical, or go back to school?
These are all big questions, and arriving at the right answers for you can be tricky. Interdependencies and tradeoffs abound. But so do opportunities. The knowledge and tools your advisor brings to the table can help shed light on possibilities, demystify the math, and integrate it all into a customized plan that reflects you and your values. Weighing the hard data in the context of what’s meaningful to you will lead to the right decisions — and the brighter future your benefactor intended to bestow on you.