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Four Steps to Take When You Receive a Large Inheritance Thumbnail

Four Steps to Take When You Receive a Large Inheritance

Four Steps to Take When You Receive a Large Inheritance

Receiving a substantial inheritance can be life-changing, and many people feel overwhelmed when they suddenly receive a large sum of money. They may want to use the gift wisely but be at a loss for how exactly to do that. Carefully assessing your financial situation, thinking through your options, and determining your financial goals are crucial steps when facing a financial windfall.

1. Put the Money in a Safe Place While You Assess Your Financial Situation 

While you decide what next steps to take, put the money in a safe place, such as a federally insured bank or credit union with a high-yield savings account. Typically, it’s wise to keep the new influx of money separate from the accounts you use for day-to-day transactions, such as your checking account, to avoid the risk of confusion or unintentional spending. With the money in a secure place, you can feel more confident taking your time to identify the best uses for these funds in your life. If you are currently working on a short- or medium-term financial goal, such as building an emergency fund, saving for a down payment on a house, or paying down debt, you can consider using some of your inheritance to expedite your progress. Otherwise, consider how you might use the money to work toward long-term goals, such as saving for retirement and investing to grow your net worth. 

2. Account for the Tax Implications

Taxes may affect the amount of inherited money available to you. If you make plans but ignore how taxes might affect your finances, you may unintentionally overspend. There is no federal inheritance tax, so it is unlikely you will have to pay taxes on a cash inheritance unless you live in one of the six US states that impose a state inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. Note that Iowa is currently phasing out its inheritance tax, which was repealed in 2021. Until January 1, 2025, inheritors in Iowa who are nonexempted beneficiaries, meaning anyone who is not a surviving spouse or linearly descended from the deceased individual (e.g., children, grandchildren), will pay a reduced inheritance tax rate based on the inherited amount and the year of death. Beginning in 2025, Iowa will no longer have an inheritance tax. 

Inherited assets other than cash, such as a brokerage account or property, may have other tax implications. The transfer of the inheritance from the original owner to the beneficiary may not be a taxable event, but the beneficiary will be responsible for income taxes on capital gains during their lifetime, such as if they receive dividends or sell an investment for profit. If you inherit a retirement account, such as an IRA or a 401(k), you may be obligated  to take required minimum distributions, meaning you must liquidate that account over a period and cannot leave it alone to grow indefinitely. Normal income tax rates will apply to those minimum required distributions. 

3. Create an Investing Strategy

Now that you’ve assessed your goals and determined how much money you will have to work with after any applicable taxes, you can begin to develop a more detailed strategy for how to use your inheritance. Once short- and medium-term goals are taken care of, you can focus on investing the rest of the money to build long-term financial security and continue your family’s tradition of passing on generational wealth. You can build wealth in a variety of ways, depending on your preferences and financial situation. One option is to increase your contributions to tax-advantaged retirement investing accounts, such as a traditional or Roth IRA or 401(k), to boost your retirement savings. If you were already investing the maximum amount in these accounts, you may consider investing the money in a brokerage account. You can invest in a lump sum or gradually invest the funds over a certain period, a strategy called dollar -cost averaging. However, you choose to invest, you should ensure your investments are diversified to mitigate the risk of loss associated with investing and give yourself the best chance for long-term success.

4. Reach Out to a Financial Advisor

If you already have a financial advisor, it’s important to reach out to make them aware of large changes to your financial situation, such as receiving an inheritance, so that they can adapt your financial plan to accurately reflect your new circumstances. If you do not yet have a financial advisor, you may benefit from hiring one to help you create a financial plan, fine-tune your investing strategies, and manage your newfound wealth. Financial professionals will charge a fee for their services, but they can help you gain confidence in your finances and avoid costly mistakes.

If you have recently received an inheritance or other financial windfall, the financial professionals at Business & Financial Strategies would love to meet with you for a 20- to 30-minute in-person or virtual initial consultation to discuss your financial circumstances and goals. They can provide personalized guidance tailored to help you make strategic moves that align with your financial priorities, time horizon, and risk tolerance. Additionally, they can help you create and follow a comprehensive financial plan to preserve and grow your wealth so you can feel confident in your financial decisions and secure in your retirement planning. If you already have a financial plan, they can help you streamline your strategies and present opportunities and perspectives you may not have considered. Business & Financial Strategies has offices in the Iowa City / Coralville area and Fairfield, Iowa, and they serve clients from all around the United States. To learn more, call 319-358-7700 or visit www.BFSFinanicalPlanning.com to schedule a complimentary initial conversation.

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