What to Do With Inheritance Money: Save, Spend or Invest?

As you mourn the loss of a loved one, you may also find something new to factor in your life and finances—an inheritance. That inevitably raises many important questions about what to do with inheritance money when you receive it. Should you save it, spend it or invest it? Or maybe all of the above?

The answer depends on several considerations, taking into account your personal situation and long-term financial goals. Here are a few options to consider as you decide how to move forward.

Working toward financial goals

When you're wondering what to do with inheritance money, keep in mind that you don't need to put it all in one place. You can split it up to help you meet your financial goals. For example, you might use 1/3 to pay down debt, then apply another 1/3 toward an important short-term goal, such as taking a family vacation, buying a new car, contributing to a down payment on a new home or renovating your existing home. Finally, you might choose to save the remaining 1/3 for long-term financial goals, such as education or retirement.

Paying off your debt

Some or all of an inheritance could help you pay off debt, which can have a profound impact on your finances overall because you can redirect those monthly payments to meet other financial goals. Aim for high-interest and non-tax-deductible debt first to reduce the added interest load. A great way to determine this is to plot all of your loan and credit card balances on a chart from the highest interest rate to the lowest. Then, work your way down from the top, paying off all or as much of the balances as you can. This approach is called the debt avalanche.

Building an emergency savings fund

Do you have funds set aside in case you lose your job or experience another form of financial hardship? Experts typically recommend building an emergency savings fund that can cover 3 to 6 months of your living expenses. Using inheritance money to supplement your savings can be a great idea, as long as it doesn't prevent you from paying down high-interest debts. The interest on your debt is likely to be higher than the interest you'd earn in a savings account, so it pays to take care of those debts first before setting aside your emergency fund.

Paying off a student loan or mortgage

If you're still wondering what to do with inheritance money after paying off other debt, consider applying it toward debt that typically gets a tax break. For example, student loans and mortgages can save you substantial amounts of interest in the long run. However, talk to your mortgage provider first. There could be a penalty for paying off the mortgage early, and you'll need to calculate whether the interest savings will outweigh any penalty costs.

Boosting your retirement savings

Did you receive an inheritance after meeting most of your financial goals? Do you still have inheritance funds left over after paying off debt? Consider talking to a financial professional about how to invest an inheritance to grow your retirement savings. It's also a good idea to review your employer retirement plans, pensions and your own personal retirement savings. You might find that you can add to your existing tax-deferred or tax-preferred accounts. You also might need to open a new account to accommodate the inheritance.

Investing in stocks and bonds

Stocks, bonds, mutual funds and other types of investments like real estate might help you meet your financial goals. When deciding how to invest an inheritance, you'll need to consider several factors, including your risk tolerance, time horizon, tax situation and other assets. A financial advisor can help you evaluate each of these factors and suggest strategies that will help you grow your investments.

Receiving an inheritance is often an emotional experience. Making clear and logical financial choices about what to do with inheritance money can be made more difficult by the grieving process. That's why it's important to talk to a financial professional before making any decisions.