How to Invest Your Inheritance

Inheritance documents

When a loved one passes away, you may receive an inheritance. This money is a token of the person’s appreciation for you and often represents a lifetime of savings. When you’ve received a large sum of money, there is a temptation to splurge on dream vacations, shopping and other fancy items. While it may be okay to spend a portion of it that way, the best option is to save and invest the money for your future. Here’s how to invest your inheritance to become set for life. A financial advisor can give you valuable guidance on how to make the best use of an inheritance.

Six Ways to Invest Your Inheritance

There are almost infinite options to invest a large sum of money from an inheritance. The options that you choose will largely be determined by how much of an inheritance that you’ve received, your current financial position and what your goals are. The following six possibilities are some of our best tips to create lifelong wealth for you and future generations.

Contribute to an IRA

Many people wish that they could contribute to an individual retirement account (IRA) each year, but daily bills often get in the way. With an inheritance, this is your opportunity to contribute to your IRA. The maximum contribution for 2021 is $6,000 per person ($7,000 if you’re 50 or older). If you have a spouse, you can also contribute to their IRA, even if they’re not working.

There are two different types of IRAs to choose from, traditional or Roth. Traditional IRAs offer a tax deduction today, but withdrawals will be taxed in retirement. If you have a workplace retirement account, income limitations apply. Roth IRAs are a popular choice because they provide tax-free withdrawals in retirement and there are no required minimum distributions as you get older. Just keep in mind that you don’t get a tax deduction for the contribution and there are income limits for high earners.

Max out your company retirement plan

Company retirement plans like 401(k) and 403(b) accounts provide a valuable opportunity to save money for retirement directly from your paycheck. For 2021, you can contribute up to $19,500 each year ($26,000 if 50 or over). Plus, some companies offer a matching contribution to encourage participation. While most plans do not allow you to write a check to contribute to the company retirement accounts, you can increase your paycheck withholding amount to max out the account. Then tap into your inheritance for the difference in your paycheck so that you can cover your normal monthly bills.

Before taking this step, discuss the matching rules with your plan provider. You may have to spread out your contributions across every paycheck in order to get the match. If you max out your contribution before year-end, you may lose out on some of the company’s matching funds.

Add to a health savings account

Health savings accounts (HSAs) are one of the best tax-advantaged investments available. Your contributions are tax-deductible, the money grows tax-deferred and withdrawals are tax-free when used for eligible medical expenses. The money can be invested in stock-based investments to receive attractive returns for years before the money is needed.

Contribution limits in 2021 are $3,600 for individuals and $7,300 for family coverage. Speak with your human resources department to ask if you can make direct contributions. Otherwise, you may have to increase your paycheck withholding amount in order to max out your HSA account.

Open a brokerage account

Stock exchange

Stock exchange

A brokerage account is an investment trading account that lets you add or withdraw money at any time without penalty. There are no limits to how much you can contribute and, unlike retirement accounts, you aren’t hit with a 10% penalty if you make a withdrawal before retirement age.

Within a brokerage account, you can invest in stocks, bonds, mutual funds, ETFs, commodities and more. And many brokerage firms have eliminated trading fees to reduce the expenses that you’ll pay for your trades. Investment gains and losses from trades within a brokerage account are reported on your tax return. Additionally, any dividends that you receive are taxable as well.

Buy rental property

Rental property investing is one of the most popular ways to invest in real estate. These properties provide monthly income from tenants and the potential for appreciation. Plus, rental properties offer attractive tax benefits for some investors.

If you’re not interested in the responsibilities of owning property directly, there are other options. You can invest in a diversified pool of real estate through real estate investment trusts (REITs), ETFs, mutual funds and FinTech apps.

Build an emergency fund

Even when you’ve received an inheritance, emergencies can still occur. And you don’t want to have all of your money invested when you need to pay for an emergency. Setting aside three to six months of your monthly expenses is a common target for emergency funds.

This money should be saved in a high-yield savings account or short-term CDs. You won’t earn much interest, but the money will be fairly liquid for when you need it the most. And with this peace of mind, your other money can stay invested so that you don’t have to sell in a hurry.

The Bottom Line

Pile of $100 bills

Pile of $100 bills

Receiving an inheritance can change your financial situation dramatically. You don’t want to waste this gift by spending all of it on frivolous purchases. When invested wisely, it can create generational wealth for you and your family. We showed you six different methods of how you can invest an inheritance to create financial success. Even if the inheritance is too small to do all of these investments, begin with one or two of these steps as you work toward your goals.

Tips for Investing an Inheritance

  • An inheritance can be life-changing when invested correctly. Our investment calculator shows the power of compounding over time when you invest today. Use the calculator to see how large your inheritance can grow based on investment returns and time.

  • Investing money from an inheritance can be challenging. You want to maximize your value while minimizing the potential for taxes. Working with a financial advisor can help you create a plan to meet your money goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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