What to Do With an Inheritance

1. Park Your Money in a High-Yield Savings Account

Inheritance is something you receive at a painful time. The experience of losing a loved one and receiving assets from an estate can create a flurry of emotions, from grief and confusion to stress, and cloud the good judgment needed to make important financial decisions.

To avoid acting on impulse, give yourself time to reflect and set aside financial decisions until you've had time to process your loss and consult with a trusted financial advisor.

Until then, consider putting the money in a high-yield savings account, where it will accrue more interest than you'd receive in a traditional savings account. You can leave your inheritance in savings until you decide how to use it in the long term; you can also keep it there to save for short-term savings goals, such as buying a house.

2. Seek Professional Advice

A financial planner or other financial professional, such as a certified public accountant or estate planning lawyer, can help make objective decisions about the best way to use your inheritance. They can help you define clear goals and reach them faster, which is especially critical if you have limited experience managing a large sum of cash.

If a financial planner was already managing the estate you've inherited, consider asking them to help you manage your inheritance. They'll have an insider's knowledge of the assets you've inherited, and you'll have confidence in their proven track record of effectively managing wealth right off the bat.

Learn more: How to Make a Financial Plan

3. Create or Add to Your Emergency Fund

If you don't already have cash saved for the unexpected, an inheritance is a good way to start. Experts recommend setting aside enough funds for three to six months' worth of basic expenses in an emergency fund. That way, you'll be covered in times of unforeseen financial burden, such as in the event of a loss of income, medical emergency or other crisis. Consider keeping these funds in their own high-yield savings account where you can access the money quickly if needed.

4. Invest in Your Future

One of the best uses for your inheritance is to invest it in your retirement. If possible, consider funding your tax-advantaged retirement account, such as a 401(k) or traditional IRA, to the maximum contribution limit, including catch-up contributions if you're over age 50.

If you've maxed out your retirement account and want to branch out, here are other options to consider:

• Diversified funds: Mutual funds, exchange-traded funds (ETFs) and index funds allow you to invest diversely in the market. In other words, you spread out your money across multiple companies or industries, mitigating risk and aiming at broad returns.
• Individual stocks: Stocks are volatile investments with both a high potential for growth and a high potential for loss. If you choose to buy shares in individual companies, decide on a set percentage of your portfolio for these risky investments, such as 5%, and make up the other 95% with your 401(k), IRA, mutual funds, bonds and the like.
• Bonds: Bonds are a secure way to invest your money for a relatively small but predictable return. You can use them to hold money you'll need in the near future, or to balance out the more volatile assets in your portfolio.

Tip: Picking your own investments can be a challenge, especially if you're just starting out. Consider working with a financial advisor to help create a portfolio you feel confident about.

5. Pay Off Your Debt

If you have a flush emergency fund and contribute enough to your 401(k) to at least take advantage of your full employer match (and ideally more), tackling high-interest debt is one of the best uses for your inheritance.

If you have a balance on a credit card or installment loan with high interest, such as 20% APR, paying off that debt is perhaps the least risky investment you can make—and the returns are immediate and high. You'll save a substantial amount in interest over time, and you can rebudget that money toward saving and investing going forward.

Just be sure you adjust your financial habits to only charge purchases to your credit card you can pay off each billing period. Otherwise, you may end up racking up more debt.

Learn more: How to Get Out of Debt

6. Consider Buying a Home

You might be able to use your inheritance to jump-start homeownership and experience the financial benefits of owning real estate, like building equity and increasing financial security.

But practice caution using all or most of your inheritance as a down payment, especially if you may struggle to afford monthly mortgage payments, property taxes, emergency repairs, renovations and other house-related costs once the house is yours. If you're too hasty in using your inheritance to leverage large purchases, you could end up taking on more debt than you can afford to pay off once the inheritance is gone.

If you already own a home and you're considering using your inheritance to pay off your mortgage, weigh the benefits of this against other potential uses for the money. Owning your home outright can bring financial security, significantly reduce monthly expenses and put you on a path to lower expenses in retirement. But since a mortgage is usually lower-interest debt, consider the trade-offs of paying off your mortgage versus investing the money for a higher return, covering other important expenses or paying off higher-interest debt.

Learn more: How to Buy a House

7. Put Money Into Your Child's College Fund

Consider allocating a portion of your inheritance to a college fund for your children. Finding the money to save for college can be a source of stress for parents, and your inheritance is a unique opportunity to get on track and help your child avoid student loans down the road.

Not only can this ease your financial burden in the future, but it's also a way to invest your inheritance in future generations, as paying for college can bolster your children's lifelong earning potential. Consider opening a 529 savings plan to house your college savings, which offers tax-free growth to save more for college.

8. Keep Moderation in Mind

When unexpected cash hits your bank account, the urge to splurge is natural. But balance this desire with reason and moderation.

Hold on to all of your inheritance until you've come up with a plan for how you'll use it to improve your financial health and long-term security, such as investing in your 401(k) or paying down debt.

Then, decide on a set amount to dedicate to spending. You could use this money for a practical purpose, such as a car upgrade or a bathroom remodel, or you could choose to spoil yourself with a vacation or a hot tub. Avoid making purchases that require long-term payments or change your lifestyle to be more expensive, such as a boat that'll need upkeep and storage. Once your inheritance is gone, these purchases could leave you worse off than you were before.

The Bottom Line

An inheritance is a windfall that can be a blessing or a curse, depending on how you manage it. Rash decisions could leave you empty-handed, whereas some smart money moves can help you build greater wealth for your future.

If you aren't sure what to do next, reach out to a financial advisor to develop a game plan for your money together.