Did you know that over 40% of Americans receive inheritance money in their lifetime? And, get this, the median inheritance amount is $69,000 (and the average ticks way higher at $707,000)! That’s no small chunk of change!
If you’re reading this article, I suspect that you have either just received an inheritance or you might be coming into some inheritance money very soon. Frankly, even though all the extra money is awesome, with the death of someone close to you, it’s just not an easy situation.
- You don’t want to blow the money (1 in 3 Americans do by the way…), but
- You don’t just want to set it aside in a savings account earning nothing either.
So what’s the best course of action? What should you actually do with inheritance money??
After experiencing a bit of this ourselves and after doing a fair amount of research, here’s the advice I’d give.
1) Do Nothing For a While
Losing a family member sucks, especially if it’s your mom or dad.
- They birthed you,
- they took care of you,
- you were blessed with their wisdom for years.
And then, just like that, they’re gone.
It’s surreal and it hurts. It’s something you never wanted to experience. And at this moment, you honestly probably don’t even want the money. You just want your parents back.
But this is life…
It’s painful and it sucks. Plain and simple. And that’s exactly why you should do absolutely nothing with the money right away. You’re too emotional and you’ll likely make bad decisions if you charge forward with decisions immediately.
If I were you, I’d park the money into a simple high-yield savings account for 6 months while you grieve. Sure, you’re not earning much interest, but who cares? Just a little while ago you had no inheritance money and were earning nothing either. So relax. It’s fine. You don’t need to deal with it now…nor should you.
Take a step back, stash the cash away, and revisit it in 6 months or so.
2) Understand the Tax Implications
Let’s say the deceased had a net worth of $500,000 and they’re willing everything to you. Don’t start planning to spend all that money just yet…because you may not get it all. There may be tax implications.
Estate Tax and Inheritance Tax
First things first, there’s tax jargon that you should understand.
There are two types of taxes that pop up when someone passes away and leaves money to a loved one:
- estate taxes, and
- inheritance taxes
They’re often used interchangeably, but they’re actually a bit different.
The main difference between the two is who is on the hook for the taxes
- Estate taxes are paid for by the estate (ie. by the property of the deceased before it’s actually handed over to the heirs)
- Inheritance taxes are paid for by the beneficiary (ie. by you after you’ve received money from an inheritance)
Federal Tax and State Tax
Along with the complexities of the estate tax vs. the inheritance tax, there are actually two more areas to understand (taxes….they suck, right??!!).
- There’s the federal tax, and
- the state tax
The Federal tax is fairly simple.
- There’s only estate tax, no inheritance tax.
- If the net worth of the deceased is under $11,580,000 (as of 2020), there’s no estate tax.
- If the net worth of the deceased is over $11,580,000, the estate is taxed at 40% for anything over that value.
So for most estates, there is no federal tax since most people won’t have an $11 million net worth when they pass.
State tax gets a little more complex since every state has their own rules. Forbes has an excellent article on this called, “Where Not to Die in 2020” (man, what a great title, right??). Essentially, it’s a run-down of all the states that have an estate tax, an inheritance tax, or maybe both.
States with Estate Tax
- New York
- Rhode Island
All states not listed above therefore do not have an estate tax.
For more detail on the exemption amounts and the tax rates, reference the Forbes article link from above (Remember? The one with the unforgettable title ;)).
States with an Inheritance Tax
- New Jersey
- Maryland (note this state has both an estate tax and an inheritance tax!)
All states not listed therefore do not have an inheritance tax.
Again, for more detail on the exemption amounts and the tax rates, reference the Forbes article link from above.
Summing Up the Taxes
Following the example we stated above about the deceased being worth $500,000. If you live in, say…Michigan (Woot woot! Represent! Sorry, couldn’t help it)…
- You wouldn’t owe any federal estate tax because the net worth of the individual was under $11.58 million.
- There would be no state estate tax because it doesn’t exist in Michigan
- And, there would be no tax on your actual inheritance because that tax also doesn’t exist in the state.
You would receive the full $500,000.
I think it goes without saying, but here is my disclaimer… I am not a tax professional. If you’re dealing with big dollars and want a 100% accurate answer for your exact situation, speak with a tax professional.
Phew! Now that we got through all that tax detail, let’s see what you should actually do with the money now that you know approximately how much you’ll net in total.
3) Honor the Loss Of Your Loved One
When you receive a bunch of money from someone because of their death, it’s only appropriate to think, “What would this person have wanted me to do with this money?”
- setting up a college fund for your kiddos
- starting a small business you’ve always wanted, but never had the money
- donating a portion of it to their favorite charity in their honor
Whatever the wish, I’m sure you have an idea based on who they were, what they believed in, and what they always talked about.
Do good with the money. Honor that person and they’ll certainly be smiling down on you when you do.
Alright, it’s time to think about your debts!
- Those nagging student loans
- That credit card debt
- Or maybe it’s those stupid car loans you’ve always regretted
Whatever it is, now is the time to pay them off and vow never to go into debt again.
Using that inheritance money to get out of consumer debt is better than anything you could buy. And, it’s the first step toward building serious wealth. Just think what you could do if you didn’t have all those payments!!
Related: Why Is It Important to Pay Off Debt?
5) Have Some Fun
If there is still money left after paying off your consumer debt, it’s time to have a little fun.
- Take a vacation
- Upgrade your house (finish the basement, upgrade the kitchen, maybe add on an entirely new room)
- Invite the entire family on a cruise
Don’t totally blow all the dollars, but feel free to spend a bit! You’ll have a blast and those memories will always remind you of the person you lost and what a great gift they gave you.
It’s time to get a little serious here. It’s time to invest some of that inheritance money! After all, you’re not getting any younger either and chances are that your retirement account isn’t quite as beefy as it should be.
Since this money is essentially after-tax money, you can invest it into a Roth IRA and avoid paying tax on the growth.
The contribution limits for a Roth in 2020 are:
- $6,000 a year if you’re under 50 years old
- $7,000 a year if you’re age 50 or older
(If you’re still working, you could instead invest your money into the Roth 401k and contribute up to $19,500 if you’re under 50, or up to $26,000 if you’re 50 or older)
Beyond this, you can invest in a Traditional IRA or regular investment accounts, but you’ll be taxed on the growth.
If you’ve made your Roth contributions and you’re set up to invest 15% of your income per year, then I’d suggest you use any remaining funds to pay off (or pay down) your mortgage!
Imagine for a second what life might be like if you had no payment of any kind whatsoever. What would your monthly budget be? $2,000? $1,500? Maybe even as low as $1,000? You’d have so much extra money every month, you wouldn’t know what to do with it. After a year, your savings could have grown by $30,000 or more simply because you have no debt payments.
It truly is an insane feeling to have absolutely no debt, but my guess is once you’re completely debt free, you’ll never go back!
8) Plan Your Legacy
If your inheritance money has brought you all the way to step #8 here, your mom and dad (or perhaps a more distant loved one) really did a great job with their money. And you know what? Perhaps it’s time for you to think about doing the same for your loved ones.
Do you have kids?
Do they have dreams of their own that your assets could help them accomplish? Why not set up a trust or will to ensure that they get what they need to make their dreams come true?
And, maybe you’ll even be able to leave enough so that they can be completely debt free as well. Wouldn’t that be amazing? Think of the legacy you’d leave for them and for their kids?
Start planning today so that your legacy can become exactly what you envision it to be.
Your Inheritance Money – What Will YOU Do With It?
I laid out the steps above for what I would do with some inheritance money. You may follow it exactly, or you might pick and choose which steps are most important to you, and that’s totally fine.
The important part is that you take your time with your decisions and you make them with a level head. If that means putting money into a simple savings account for a solid year or two, that’s okay! Just don’t go out and buy ten Corvettes and try to justify that it’s smart…
So what is it for you? What would you do with your inheritance money?
- Pay off consumer debt?
- Go on a big trip?
- Give some away?
- Or maybe it’s something totally unique!
I’d love to hear from you. What would you do with the money? Or maybe it’s a statement about what you’ve already done with it! Let us know and leave a comment below!!
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.