Impact of an Inheritance on Retirement Planning

A real and unfortunate part of life as you head toward older age is dealing with the loss of family members. Depending on your relationship — whether they’re a parent, grandparent, or sibling — they could leave some or all their money with you. While this often comes with mixed emotions, receiving an inheritance, big or small, can drastically influence how you plan to live your life after you send in that retirement letter.

In this article, we’ll lay out the opportunities an inheritance windfall can present for your retirement plan and, including the insights of financial advisory experts, highlight what actions to take if you receive one. We’ll also discuss some common pitfalls to avoid when receiving a large sum of money and the mindset you can adopt.

Opportunities an Inheritance Presents

An inheritance can create many opportunities for your finances in both the long and short term. For instance, it can allow you to finally pay off debts you’ve felt like you were a long way from handling or build up your emergency fund. When it comes to retirement planning, though, the extra money can allow you to invest more, increase savings, and potentially accelerate your timeline.

“Inheriting money in your working years can easily fast track retirement,” says Morgan Veth, CFP, vice president and financial advisor at Bogart Wealth. “If the amount you inherit is equal to or exceeds the accumulation goal for the remaining working years then it can be a game changer.”

However, it will be the size of the amount of money you’ve received and your current financial picture that will dictate what you’ll be able to do with it. If it’s an exceptionally large sum, it may enable you to almost immediately begin your retirement. However, even a smaller amount of money on top of your regular income can help clear the path, helping you maximize contributions to accounts, pay debts, or save more.

“When someone inherits money, they may have received an instant retirement nest egg,” says Donna Stefans, Esq., AIF, attorney and founder of Stefans Law Group PC in Woodbury, New York. “Depending on what their full financial picture is after debt payoff is considered, there is potential to create a monthly retirement income stream. Even if a person hasn’t saved much for themselves, the inheritance can propel them into a safe zone of having money to support them in retirement,” she continues. 

Actions To Take Following an Inheritance

What should you do after an inheritance? The actions you take upon and after getting a windfall from an inheritance are critical. Making the right choices could be the difference between the funds being effective for your retirement plans or not.

Here are some immediate actions to keep in mind:

Consider How You’ll Receive It

According to Veth, one of the first considerations you’ll need to make is deciding how you want to receive the inheritance. Specifically, she says to “ensure you are setting up the appropriate accounts to receive the inheritance and assets are transferred to the new accounts correctly.” She cautions, “You don’t want to hastily provide your bank information to receive a wire distribution from a traditional IRA you inherited, for example.”

Meet With a Financial Advisor

Perhaps the most important action to take, Veth recommends, “is to meet with your financial advisor.” A professional will be able to assess how you’ll receive your inheritance, how it will fit into your plans, and, if applicable, ways to allocate the funds in your investment portfolio. Then, they can help you put together a tailored strategy that can take you through to retirement.

When you meet with an advisor or retirement planner, they’ll want to gauge facts about you, such as your preferred time horizon, goals, risk tolerance, and the overall state of your current financial picture (e.g., debts, expenses, assets, and income). Per Stefans, this includes asking questions like “Is the portfolio suited to their risk tolerance and time horizon for using the money? What debt does the person have, and should that take priority? What are the tax implications?”

It’s important, however, to ensure you work with a financial advisor who has your best interests in mind. Look for experts who use a fee-only structure and follow a fiduciary duty. In the retirement planning field, they’ll commonly have high-quality designations such as Certified Financial Planner (CFP), Chartered Retirement Planning Counselor (CRPC), and Retirement Income Certified Professional (RICP). To find a reputable professional in your area, we recommend using this free matching tool.

Reflect on What You Want to Achieve

While an advisor can help diagnose how to handle an inheritance, it’s vital to ask yourself what you want to achieve with it. Consider, for example, what age you want to retire and whether your newfound money can help you do so.

If you’ve received the windfall right ahead of retirement, it could very well position you to end your career ahead of schedule. Even so, be sure to deeply ponder what you value and where the funds can help the most. It might not have to be the end-all ticket to early retirement but could also be supplementary to other areas of your life, like paying off your house.

“Often times, people aren’t in the best state of mind after losing a loved one, so take the time to really consider how the money can enhance your financial plan and goals,” Veth says. “If you aren’t itching to retire early or have already saved enough to meet your own needs, consider using the inheritance to fulfill other goals like college-funding for a grandchild or charitable giving.”

Pitfalls to Avoid

Not unlike winning the lottery or cashing out a company, inheritances tend to bring about a great deal of excitement. You might dream of what you could do and how the new money will change your life. However, while there are actions you should take immediately after benefitting from an inheritance, there are mistakes to avoid to ensure the safety of your wealth:

Spending Impulsively

“People should avoid immediate spending before seeking guidance and establishing a spending and savings plan,” says Stefans. Though it can be tempting, if you haven’t yet met with a financial advisor and start thinking of impulsive ways to spend your money — a new car, luxurious vacations, or expensive clothes — you could seriously and quickly reduce the size of your nest egg. This isn’t to say that you can’t purchase these things, but it pays to be intentional about its effect on the rest of your plans.

Liquidating Retirement Accounts Early

Another spending-related mistake is trying to get your hands on money locked away in retirement accounts early, which can lead to expensive penalties. “For example, if the inheritance is a qualified account such as a 401K or an IRA, liquidating for spending could cost up to 40% in income tax consequences depending on the amount and their tax bracket!” Stefans says. If you haven’t turned 59.5 years old, you won’t be able to access the funds in these accounts without penalty.

Overlooking Taxes

There are many tax implications to consider when you receive an inheritance from a loved one, including:

• Capital gains tax. For example, if you receive a home as part of the inheritance and sell it, you’ll need to pay capital gains tax. The same is true if you sell shares of a company your relative owned.
• Income tax. You may also need to pay income tax on withdrawals you make from tax-deferred retirement accounts you inherit.
• Inheritance tax. As of 2024, six states impose varying inheritance tax, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
• Higher tax bracket. You could end up in a higher tax bracket after receiving the money.

Because there are so many potentially complex tax challenges that surround receiving assets or cash from an inheritance, it’s a good idea to meet with a tax professional or financial advisor. They can provide guidance on how to handle taxes and remain compliant.

Overestimation

Finally, it’s important to ensure you don’t overestimate just how far your inheritance can take you. Sometimes, you may see the large number and believe it could last well into your retirement; however, without careful planning, it can be possible to burn through the funds quickly. In some cases, overestimation and increased spending could leave you with less than you had before you received the inheritance.

“Seek the help of a financial advisor, accountant, and attorney before making any immediate spending decisions,” Stefans says. “If you can, keep the money invested, don’t touch it if you don’t have to, and let it grow as much as possible to help you achieve the retirement life you always dreamed of!”

Bottom Line

After receiving an inheritance, you may have various mixed feelings. On one hand, it’s never easy to lose someone you love, and it might feel uncomfortable being the beneficiary of what they once owned. On the other, it’s hard not to begin imagining the positive change an inheritance can bring to your life.

A strong mindset to adopt following an inheritance, according to Stefans, is to think of it as a tool for the future rather than the present. “If possible, save this money for the future as if you didn’t receive it in your hands,” she says. “It can give you a happy, secure retirement and allow you to enjoy life and not just live off your social security income. Working hard and living financially stressed in retirement can be avoided.”

When considering its impact on retirement, carefully think about how you can responsibly use the money to achieve what you’ve always wanted. Maybe you want to pay off your house, put your child through college, or enjoy a steady income in the future. An infusion of cash of any size can grant you some breathing room and potentially even help you cross the finish line earlier than you intended with a plan and a professional by your side.