Maximizing Your Cash Inheritance: Smart Investment Strategies

There are many ways to invest a cash inheritance, but it's important to approach this newfound wealth with caution and a clear plan. Here are some steps to consider:

- Take it slow and make a plan – evaluate your financial situation and prioritise how the inheritance is used.

- Pay off any high-interest debt, such as credit cards or personal loans.

- Build an emergency fund – it's recommended to have three to six months' worth of expenses saved.

- Invest the remainder of your inheritance in stocks, bonds, funds, real estate, gold, cryptocurrencies or other alternative investments.

- Get advice if needed – investing an inheritance can be complex and emotional, so consider seeking professional financial advice to guide you through the process and help you understand the tax implications.

Understand the tax implications

The tax implications of your inheritance will depend on where you live and the types of assets you've inherited.

Federal Taxes

In 2024, federal estate taxes only apply to estates worth $13.61 million or more. Unless you inherit a large sum of money, you probably won't have to worry about federal estate taxes.

There is no federal inheritance tax in the US.

State Taxes

Some states have their own estate and inheritance tax laws, and these vary. Only a handful of states levy an inheritance tax, and even then, certain beneficiaries are often exempt. For example, in 2024, only six states impose an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In Pennsylvania, spouses are exempt from paying inheritance tax, but direct lineal descendants must pay 4.5% on inherited property.

If you live in a state that imposes inheritance taxes, you may be able to minimize your tax bill by consulting a qualified tax expert.

Capital Gains Tax

Certain types of inherited assets may be subject to capital gains tax. For example, if you inherit securities or real estate, you may have to pay capital gains tax if you sell them. You will need to know the value of these assets at the time of the person's death to calculate your cost basis.

If you inherit an IRA or 401(k), the distributions you take may be taxable, depending on the type of account and your relationship to the decedent. Consult the IRS guidelines for more information.

Seek financial advice

Seeking financial advice when investing a cash inheritance is a prudent step to ensure you make the most of your windfall. Here are some detailed suggestions on how to do this:

Take Your Time

There is no rush to make immediate decisions about your inheritance. Take time to grieve and process the situation. You can park your cash in a money market account or a federally insured bank or credit union account in the meantime. These accounts are safe and insured, allowing you to make decisions without pressure.

Consult a Financial Planner

Consider hiring a fee-only financial planner who charges a flat rate for their services. This type of planner avoids potential conflicts of interest by not earning commissions from steering you towards particular investments. A financial planner can help you create a comprehensive, personalised investment strategy that aligns with your goals and considers your entire financial picture, including any non-cash assets you've inherited.

Understand Tax Implications

A financial advisor can help you navigate the tax implications of your inheritance. While you generally won't owe tax on inherited cash, other inherited assets like securities, retirement accounts, or real estate may have tax consequences. Understanding these implications can help you make informed decisions and avoid unexpected costs.

Prioritise Debt Repayment

Use your inheritance to pay off high-interest debt, such as credit card debt or personal loans. Clearing these debts can provide financial relief and improve your overall financial health.

Build an Emergency Fund

If you don't already have an emergency fund, consider allocating a portion of your inheritance to build one. Aim to save three to six months' worth of expenses in a money market account or another easily accessible account. This fund will help you handle unexpected expenses or financial setbacks without derailing your financial stability.

Invest for the Future

With your immediate financial needs addressed, you can start investing for the long term. Work with your financial advisor to determine an investment strategy that suits your risk tolerance and financial goals. Diversifying your investments across various asset classes, such as stocks, bonds, real estate, or alternative investments, can help balance risk and return.

Remember, it's essential to choose a financial advisor carefully. Ensure they are a fiduciary, experienced in similar situations, and offer transparent payment terms. Their guidance can help you make the most of your inheritance and set you on a path towards financial security.

Pay off high-interest debt

If you've inherited a large sum of money, it's important to take your time and not rush into any decisions. One good use of an inheritance is to pay off high-interest debt, such as credit card debt or personal loans.

High-interest debt can accumulate quickly and cost you more in the long run. By paying off these debts first, you can save a significant amount of money that would otherwise go towards interest payments. This is known as the avalanche method.

When deciding whether to pay off high-interest debt, consider the following:

• What are the tax consequences if you draw down on the inheritance?
• What are the details of your debt? How much are you paying in interest? What is the term? Is it a fixed or variable rate?
• Do you have a cash cushion? If you don't, why not? Are you living beyond your means?
• What are your financial goals, risk tolerance, and overall financial plan?

It's also important to remember that inheriting a large sum of money can be emotionally challenging. Common emotions that can cloud judgement include guilt, anger, sadness, and fear. It's important to consider how your emotions might be influencing your financial decisions.

Seeking professional financial advice can be helpful when deciding how to use an inheritance. A financial advisor can guide you through the process, help you understand the tax implications, and create a comprehensive investment strategy that aligns with your financial goals.

Build an emergency fund

Building an emergency fund is an essential step in achieving financial security. An emergency fund is a cash reserve that can help you navigate unexpected financial emergencies, such as car repairs, medical bills, or a loss of income. Here are some detailed steps to help you build a robust emergency fund using your cash inheritance:

Determine the Amount You Need:

The amount you should set aside for emergencies depends on your unique situation. Consider your monthly expenses, including rent, utilities, groceries, and any other essential payments. A common recommendation is to save enough to cover at least three to six months' worth of living expenses. However, if you have a large family or are self-employed, you may want to aim for a more substantial cushion, such as eight months' worth of expenses.

Set Smaller Goals:

To make the task more manageable, set smaller savings goals. Instead of feeling overwhelmed by the total amount, break it down into achievable milestones. For example, start by aiming to save enough for one month's expenses, and then gradually increase your goal. This approach will help you stay motivated and build momentum as you work towards your final target.

Start with Small, Regular Contributions:

Begin by setting aside a small, manageable amount from your inheritance at regular intervals. You can automate this process by setting up recurring transfers from your checking account to your savings account. This way, you can build your emergency fund gradually without feeling a strain on your daily finances.

Make it a Habit:

Consistency is key when it comes to saving. Treat your contributions to the emergency fund as a non-negotiable expense. Make it a habit, just like paying your monthly bills. By regularly putting money aside, you'll be surprised at how quickly your savings can grow.

Choose the Right Account:

Select an appropriate account to hold your emergency fund. Look for a savings or money market account that is easily accessible but not instantly. You want the money to be readily available when needed, but not so easily accessible that you're tempted to spend it on non-emergencies. Consider linking this account to your checking account for convenience.

Avoid Unnecessary Spending:

While building your emergency fund, be mindful of your spending habits. Avoid increasing your monthly expenses or making impulsive purchases. Remember, the goal is to prioritize savings over unnecessary spending. If you find yourself with extra money at the end of the month, consider adding it to your emergency fund to boost your progress.

Don't Over-Save:

Once you've reached your target amount, there's no need to keep adding to your emergency fund indefinitely. Instead, redirect your savings to other financial goals, such as retirement accounts or investments. This way, you can maximize the potential of your savings and ensure that all your financial needs are being addressed.

Remember, building an emergency fund is a crucial step towards financial stability. It will provide you with peace of mind, knowing that you have a safety net to fall back on during unexpected financial challenges. By following these steps, you can effectively utilize your cash inheritance to build a robust emergency fund that will protect you and your family.

Invest for the future

When investing a cash inheritance, it is important to take a slow and measured approach. Take time to evaluate your financial situation and priorities, and consider seeking professional financial advice. Here are some options to invest for the future:

• Pay off high-interest debt: If you have high-interest debt, such as credit cards or personal loans, consider using your inheritance to pay it off. This can improve your credit score and reduce financial stress.
• Build an emergency fund: Ensure you have sufficient savings to cover three to six months' worth of expenses. Keep your emergency fund in a money market account or a Roth IRA to allow your savings to grow.
• Invest in stocks, bonds, and funds: Consider investing in a variety of stocks, bonds, and mutual funds to diversify your portfolio and manage risk. Seek advice from a financial advisor to understand the different types of investments and their potential risks and returns.
• Utilize tax-advantaged accounts: Take advantage of tax-efficient investment options, such as a Roth IRA or a traditional IRA. These accounts offer tax benefits that can help maximize your investment returns.
• Real estate: If you have sufficient funds, consider investing in real estate. You can purchase a rental property outright or explore other real estate investment options. Real estate can provide a stable income stream and potential capital appreciation over time.
• Retirement savings: Boost your retirement savings by investing a portion of your inheritance. This can help you build a solid nest egg for the future and take advantage of compound interest.

Frequently asked questions