When you receive a significant inheritance, you may be tempted to view it as a windfall that you can spend freely. But unless your current financial plan ensures you’ll comfortably reach all your goals, it’s a good idea to have a roadmap for managing your newfound wealth. Formulating such a map requires consideration of several key factors.

Types of Assets Inherited

If you receive a cash bequest, you’d be wise to initially park it in a “safe” spot. You can simply open an account in a financial institution that will be protected by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures accounts only up to $250,000, so you may need to open multiple accounts to ensure appropriate coverage while you’re evaluating your options.

However, many inheritances aren’t cash. You might inherit property, securities or retirement accounts, all of which come with multiple decision points. Depending on the type of assets you inherit, you’ll need to decide whether to sell or hold them. The choice can involve a web of thorny issues.

For instance, although you and your siblings might have an emotional connection to a vacation home that’s been in the family for generations, are you willing to shoulder the costs of maintaining it? It also can be difficult to work out a mutually satisfactory plan for family members to use the property.

If you inherit a retirement account, you might want to change the asset allocation to better suit your circumstances. Retirement accounts also may be subject to tax-related requirements.

Tax Issues

Keep in mind twelve states and the District of Columbia have estate taxes and six states have inheritance taxes. Maryland is the only state that has both an estate tax and an inheritance tax.

These states have inheritance taxes:

• Iowa: up to 15%.
• Kentucky: up to 16%.
• Maryland: up to 10%.
• Nebraska: 1% to 18%.
• New Jersey: up to 16%.
• Pennsylvania: up to 15%.

Fortunately, the unified federal gift and estate tax exemption for 2023 is $12.92 million (effectively $25.84 million for a married couple). The exemption is adjusted for inflation annually in $10,000 increments. The inflation-adjusted figure for 2024 is $13.61 million (effectively $27.22 million for a married couple). So, the federal estate tax is unlikely to apply to your inheritance. But that doesn’t mean you can ignore tax issues altogether.

Tax issues you’ll encounter with inherited assets often come up with retirement assets. You generally aren’t taxed on the amount you inherit, but you may be taxed when you take distributions, depending on the type of account. For example, distributions from traditional IRAs are taxed as ordinary income, but distributions from Roth IRAs aren’t.

In addition, tax rules may require you to distribute the entire balance of an account within a certain number of years, depending in part on your relationship to the decedent. (The IRS also has proposed regulations requiring some beneficiaries to take annual taxable distributions throughout that period). Required distributions could push you into a higher tax rate bracket.

What if you decide to sell securities or property that you inherited? You’ll benefit from “stepped up basis.” This increases the tax basis of inherited assets to their fair market values at the time of the decedent’s death (or an “alternate valuation” date of six months after the date of death if the executor so elects). The stepped-up basis can significantly reduce the capital gains tax upon sale.

Types of Debt You Currently Owe

You might think the most financially responsible course of action is to use your inheritance to immediately pay off all your debts. Not so fast!

In light of today’s rising interest rates, early payoff probably makes sense if you’re carrying variable rate debt or high-interest debt, such as credit card balances and certain student loan debt. But all debt isn’t equal. With other debt — for example, mortgages with historically low fixed rates — you might be better off buying investments with expected rates of return that exceed the interest rate you’re paying on the debt. Plus, paying off your mortgage early could forfeit some tax benefits.

There’s No Rush

Most people who receive a large inheritance have just lost a loved one. This can be an emotional and challenging time, even without the added financial element. Taking the time to develop your plan can help make the most of your inheritance and save you further stress down the road.

Contact us for help executing a game plan that makes the most sense for your situation, including any long-term estate planning goals that reflect your newfound wealth.