Sudden Wealth: 3 Essential tips for inheriting money

By Mike Zarrelli

When Sarah’s father passed away, she was devastated. Amid the grief and the logistics of settling his estate, she learned she would inherit $500,000. While she was very excited about the opportunities the money would open up, she was still mourning the death of a parent, feeling guilty for daydreaming about buying a home, and stressed about using the money in a way that would honor her dad’s legacy. You can imagine all of her emotions, right?

Sarah’s experience is quite common. Receiving an inheritance often comes with mixed emotions, grief and responsibility with a splash of financial anxiety. With all of these emotions in play, it is easy to make impulse decisions on how to use the money which could lead to regret down the road.

The key is to approach an inheritance (like most things in life) with a clear plan, ensuring you maximize the money’s impact on your life. Here are three essential things to think about when receiving an inheritance:

1. Avoid these common mistakes!

First, do not assume you’ll receive an inheritance. It is the old adage, "Don’t count your eggs before they hatch." Relying on an inheritance before it is in your hand can lead to overspending and impact your relationship with the deceased. Things can change without your knowing.

Maybe they had hefty medical expenses before passing, or their heart desired to leave a large sum to charity. Until the money is officially yours, it’s best to plan your financial future based on what you can control, not what you expect.

The next biggest mistake people make is overestimating the value of their inheritance. There’s a huge difference between inheriting $250,000 and inheriting $1 million. While both are life-changing amounts, one provides a significant financial boost, while the other could lead to true financial independence.

After that, a common issue I’ve seen is mental double-accounting. This is when people start allocating the money in their heads multiple times. They might plan to pay off debt, and put a downpayment on a house, and get a new car, and fund their kids' 529s, and invest for retirement, and just like that…they’ve already spent the same dollars multiple times. Before making any moves, take a step back to fully appreciate and understand what the inheritance can realistically do for you.

2. Take time before making big decisions

One of the first things I tell clients who are expecting an inheritance is this: pause. Grief and sudden financial changes are a volatile mix, and the best financial decisions are made with a clear head.

Rushing into life-changing decisions, whether it is buying a home, deciding to make a career shift, or retiring before running the numbers, can lead to major regret. Instead, take time to process your emotions and get your affairs in order. When you’re ready, brainstorm all the ways the money could be used. From there, rank each opportunity to determine what will provide the most fulfillment and long-term benefit in your life.

Bonus Tip: Use a bucket strategy

A simple yet effective way to approach an inheritance is through a bucket strategy, where the money is divided into different priorities:

• Bucket #1: Financial Stability – Pay off high-interest debt, top off your emergency fund, and cover upcoming large expenses.

• Bucket #2: Enjoyment & Lifestyle – Use a portion for travel, experiences, or meaningful purchases that align with your values.

• Bucket #3: Future Wealth – Keep some funds invested for long-term financial security, such as retirement or making work optional. You won’t regret it!
The bucket strategy is designed to help find balance, allowing you to enjoy the new-found wealth today and tomorrow.

3. Death and Taxes: Understand your new tax burden

Not all inherited assets are treated the same when it comes to taxes. Failing to understand the tax implications can lead to the worst kind of surprise…a larger-than-expected tax bill come April 15th.

• Inherited Real Estate & Investments – Many assets receive a step-up in cost basis to the market value on the date of death (DOD). For example, if your loved one bought a house for $500,000 and was worth $1 million at their passing, then your new cost basis is $1 million. If you sell the home right away, you may not owe any capital gains tax. However, if you sell the home several months down the road for $1.2 million, you’ll owe capital gains tax on the $200,000 gain—not the full amount.

• Inherited IRAs – These accounts must be withdrawn within 10 years under the current 10-year inherited IRA rules. To further complicate things, if the original owner had started their required minimum distributions (RMDs for folks older than 73), you’ll need to continue taking them. Keep in mind, that every withdrawal from an inherited IRA is taxed as income. It’s like receiving an extra paycheck or bonus. So, strategically timing your distributions, such as withdrawing larger sums in lower-income years, can reduce your lifetime tax bill and prevent unnecessary tax hits.

• State Inheritance Taxes – Currently, six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, & Pennsylvania) impose an inheritance tax that beneficiaries must pay. Remember, estate taxes are paid by the deceased, and inheritance taxes are paid by the people receiving the inheritance. Knowing whether this tax applies to you can help you prepare accordingly and set expectations for the after-tax inheritance you may receive.

Final thoughts

An inheritance is a rare financial opportunity, but without a plan, it can disappear quickly. By being aware of common inheritance mistakes, giving yourself time to process, and understanding the tax implications, you’ll be in a great position to make the most of the inheritance. Pairing these with frameworks like the bucket strategy can help you build toward the life you want while honoring the legacy of the person who left it to you.

Mike is a Certified Financial Planner with Financial Services Advisory in Rockville, Md. He studied financial planning and accounting at Salisbury University. During his time at Salisbury, he was an active member of the Financial Management Association and was treasurer of his fraternity, Pi Lambda Phi.