Investing can be complicated; there are so many investment options, all with confusing tax implications. Investing inherited money comes with an additional layer of emotional complexity. Additionally, inheritances can be larger sums of money than many of us are used to managing, making it even more important to make sound investment decisions.
Our goal with this article is to help you navigate the financial side of investing inherited money. We’ll show you:
- A few quick pre-planning tips,
- Ways to invest inherited money (as well as the tax implications of your options),
- And how to handle non-cash inheritance.
Pre-Planning Tips for Managing an Inheritance
If you are in the planning stage of accepting an anticipated inheritance, there are a few things you can do now to make things easier for yourself in the future. At least from a financial standpoint.
1. Consider Speaking with Your Loved Ones About Their Wishes
This can be a difficult conversation to have. It’s also an important one. Not only for financial planning but also for your loved one’s peace of mind. They may have specific wishes about their end-of-life care, funeral arrangements, and everything they’ll leave behind. Talking about their preferences can help assure them that the family will follow through to make sure things are handled properly.
2. Try to Respect Your Loved Ones’ Wishes
In many cases, loved ones make decisions that the family doesn’t fully agree with. But it is their decision to make. Try to make peace with their choices, even if you don’t agree with them.
3. Never Assume You are Due an Inheritance
Even if your loved ones have discussed leaving money or assets to you, it’s generally best not to plan your finances around the expectation of inheritance. Plans and circumstances can change. For example, end-of-life care can quickly deplete savings, leaving less money available for beneficiaries. Don’t count on the inheritance until it is received.
How to Invest Inherited Money
Before we get into how to invest inherited money, it’s important to note that you don’t have to make a decision immediately. Losing a loved one can leave you reeling, and you don’t want to be forced into making important financial decisions in that state.
Now, we typically don’t advise keeping a large amount in a traditional savings account. In previous articles on saving vs. investing, we have explained that savings accounts offer very little growth potential, while investing gives you a chance to multiply your money over time. But inheritance is an exception. If you need time to grieve before addressing your finances, take it. You can stash the cash safely in an FDIC-insured savings account, where it will be protected until you’re ready to make sound investment decisions.
If you’re feeling up to it, you could also choose from some low-risk, short-term investment options that provide better returns than traditional savings accounts, such as:
- Certificates of Deposit (CDs)
- Treasury bills, or
- Money market accounts.
These options allow you to grow your inheritance while you take the time you need before creating a longer-term plan.
Investing Inherited Money in 3 Steps
Step 1: Establish a Plan
As with any sudden income, you have four basic options for your inheritance:
- Give it away. You might decide to use a percentage of your inheritance to make a donation in your loved ones’ name to a local charity.
- Use it to pay down debt. If you have high-interest debt (like credit card debt), paying off the balance could save you a lot of money in interest. For low-interest debt, however, you might be better off investing instead of paying off the debt. For example, if your mortgage interest rate is 4%, but you could earn 5% or more on an investment, you’ll come out ahead by investing.
- Spend it. Having a tangible gift from your loved one can be healing. Maybe you decide to spend a portion of your inheritance on a new dining set, for example, and every time you look at it, you’re reminded of your loved one.
- Invest it. Of these options, investing is the only one that will grow your inheritance over time. With the other three options, once you use the money, it’s gone. But if you invest, you could improve your financial prospects for the long term, potentially even building generational wealth that will benefit your children and grandchildren.
You can split your inheritance among these categories however you like.
Step 2: Choose Your Investment Types
For the amount you decide to invest, you’ll need to decide what, exactly, to invest in.
Your investment types should be determined by your goals. In many cases, this comes down to cash flow vs. appreciation. Are you more interested in generating income from your investments or building value over time?
If you’re looking for passive income, consider investment options like
- Real Estate Investment Trusts (REITs). REITs are companies that invest in income-producing real estate and share the income with investors. Buying a share of a REIT entitles you to a share of that REIT’s profits.
- Dividend stocks. Some companies regularly pay dividends to stockholders. These companies are less likely to see major gains in stock prices, but the cash flow is the benefit.
If you’re looking for long-term appreciation, consider investment options like
- Raw land. You might decide to purchase land just outside an expanding town or city. Years from now, the value of that land could have grown substantially.
- Commodities. Commodities are substances that are valuable for what they are, rather than for who produces or distributes them. Examples include precious metals, agricultural products, and even computer memory.
There are also a few investment options that offer both income and appreciation:
- Multi-family rentals. You could invest in a rental property with multiple units. Not only would the property grow in value over time, but each unit would provide a separate income stream.
- Built-to-rent (BTR) homes. BTR homes are designed and constructed with the express intention of serving as long-term rentals. This investment type serves a growing niche of renters who want the lifestyle of homeownership without the upfront expense.
You don’t have to buy a rental property to take advantage of income and appreciation. If your inheritance isn’t enough to cover a property purchase, or if you simply prefer a more passive approach to real estate investing, you can invest in real estate syndication. Syndication involves pooling funds from multiple investors to finance a professionally managed real estate project. This offers the financial benefits of rental property ownership without the effort or upfront expense.
Step 3 Place Your Investments
Once you decide which investment types best serve your financial goals, you can place your investments. The process of placing your investment will depend on your chosen investment types. If you choose to invest in securities (like stocks, bonds, REITs, or funds), you can place your investment with an investment broker or online platform.
If you decide to purchase real estate, you’ll want to work with a real estate agent to find and secure your new property. And, if you decide to invest in syndication, you can place your investment online directly with the real estate syndication company of your choice.
What About Tax Implications?
There are two tax types to be aware of: estate tax and inheritance tax. Estate tax is charged to the estate before the inheritance is calculated and distributed. Inheritance taxes are charged to the beneficiary after they receive their inheritance.
For 2024, the IRS does not require any federal estate tax on the transfer of estates valued below $13,610,000. And there is no federal inheritance tax.
However, individual states may charge estate and/or inheritance taxes. There are typically thresholds the estate or inheritance needs to meet before taxes are levied. For example, Maryland charges both estate and inheritance taxes, but only on estates valued at more than $5 million. The Taxpayer Foundation has a state-by-state tax cheat sheet so you can check the details on your state.
How to Handle Non-Cash Inheritance
Of course, not all inheritance comes in the form of cash. While we can’t cover every possible inheritance scenario, here are a few common non-cash inheritance types, and some general tips for managing them.
Real Estate
If you inherit a property, you have the option to either:
- Live in it yourself,
- Rent it out, or
- Sell it.
You should note the value of the property as of the date you inherited it. This will be your new “cost basis” for tax purposes. The cost basis is necessary for calculating depreciation tax deductions if you decide to rent the property out and for calculating taxable profits if you decide to sell at any point.
Businesses
If you inherit a business, you can:
- Run the business yourself (perhaps with the help of an experienced manager),
- Sell the business, or
- Otherwise liquidate the business (stop operations altogether).
Similar to real estate, the cost basis for the business will be the value on the date you inherited the business. You’ll want to note this value in case you eventually sell the business.
Collectibles
Collectibles can range from art, stamps, and jewelry to comics, action figures, and games. You can keep the collection, sell it, donate it, or split it up and go piece by piece. If you decide to donate, you might be able to arrange a free pick-up with a local donation center. And if you decide to sell, you might consider hiring an estate sale company to handle the process for you if you don’t have the time or capacity to handle the sale on your own.
Just like with real estate and businesses, your cost basis for inherited collectibles is the value as of the date of the inheritance. You’ll pay taxes only on the amount of profit you make from the sale, which is calculated as the sales price minus your cost basis.
Retirement Accounts
Inherited retirement accounts are complicated. The way you handle the funds depends on your relationship with the original account holder. Spouses are offered options that other beneficiaries are not. Additionally, tax implications depend on whether the account is tax-deferred (like a 401(k) or IRA) or post-tax (like a Roth IRA).
We strongly recommend seeking the professional advice of a certified financial planner for managing inherited retirement accounts. Having said that, here is some information about your options.
For Surviving Spouses
If you inherit your spouse’s retirement account, you have three options:
- Leave the funds in the original account. In many cases, spouses can simply take control of the existing account. However, you might have to take out required minimum distributions (RMDs) and empty the entire account within 10 years of taking control of the account.
- Transfer the funds to your retirement account. This option allows you to take control of the funds, without RMDs (at least not until you turn 73).
- Take a lump sum payout. There are no penalties for taking a lump sum. However, if the account was a tax-deferred account, the payout would be considered normal income for tax purposes. This could potentially result in an unexpectedly large income tax bill, especially if the payout causes you to move up into a higher tax bracket.
For Other Beneficiaries
Non-spouse beneficiaries have two options:
- Transfer the funds to a new inherited IRA account. In many cases, you will need to take the RMDs of this account to drain the account within 10 years. However, eligible designated beneficiaries (like minor children, those with a disability, and those who are less than 10 years younger than the original account holder) may opt for an RMD based on their life expectancy, rather than the 10-year rule.
- Take a lump sum payout. There are no penalties for taking a lump sum, but there are serious potential tax implications. If the account was tax-deferred, the payout will be taxed as normal income.
Stocks, Bonds, and Other Securities
If you inherit an investment account with stocks, bonds, and/or other securities, you can either:
- Keep the funds invested as-is or
- Restructure the investments to align with your financial goals. If, for example, you’re willing to take more risk for greater reward potential, you may wish to sell any low-risk, low-yield securities and reinvest in those funds in something with greater yield potential (like the real estate syndication investments discussed previously).
The Bottom Line
Losing a loved one is difficult. And managing finances can also be difficult. So doing both in quick succession can be extra difficult. When investing inherited money, it’s important to take your time and consider how this money can be best used to enhance your financial position and pay respect to your loved one’s legacy.
If you’re interested in using your inheritance to invest in passive real estate opportunities, like the real estate syndication option mentioned in this article, Gatsby Investment is here to help. We offer a wide range of real estate projects with strong return potential to give your inherited money a chance to grow. You can learn more about investing with Gatsby through our website or contact us to arrange a free personal consultation with a Gatsby Investment representative.