Receiving an inheritance can often come with mixed emotions, and working out what to do with a potentially life-changing sum of money can feel quite stressful or even overwhelming.

While we can’t tell you exactly what to do with your inheritance, we can suggest a few sensible options worth considering.

A financial planner will help you to make informed decisions based on your personal circumstances

Start off with a financial plan

Inheriting a large sum of money could leave you with the freedom – and the bank balance – to change your life. But working out what to do with your inherited wealth will ultimately depend on where your priorities lie.

Whenever you’re about to experience a life-changing event, it’s worth talking to a professional financial planner. They will help you to put things into perspective and allow you to make informed decisions based on your personal circumstances.

For example, a financial planner will consider a range of different issues, including your age, your current financial situation, and the amount you’ve inherited. But they’ll also want to establish your financial and personal life goals, including the type of retirement you’d like to have. There’s no ‘one-size-fits-all’ approach, as everyone’s priorities and circumstances will be different.

All the information gathered will enable your financial planner to design a long-term roadmap, helping you achieve your (and your family’s) goals.

You could pay off high-interest debts

People tend to accumulate high-interest debt in their 20s and 30s, often in the form of credit cards, store cards, overdrafts and personal loans. Getting rid of this debt is definitely a good idea, as the higher rate of interest paid on these types of debts can often be a drain on personal income.

Using an inheritance to pay off debts is a good way to get your bank balance in the black instead of the red. You’ll save a significant amount of interest over time, and that money can instead be used towards establishing some savings and investments for the future.

But think carefully before paying off a mortgage

Homeowners often dream about paying off their mortgage early. With an inherited lump sum, this dream could become a reality.

One of the advantages of paying off a mortgage (or a large portion of it) is that it can potentially save you thousands of pounds in interest payments. It may also be a financial weight off your mind, which may be motivation enough for doing it.

However, it’s important to take a step back before committing to paying off your mortgage. Despite recent rate increases, mortgage debt is usually low compared to other forms of lending. So, depending on the term remaining on your mortgage, you may find it financially beneficial to repay higher interest debts first.

Mortgages often charge fees if you repay the mortgage early too – especially if you have a fixed rate or discounted mortgage. Be sure to check the terms of your mortgage to ensure that the early-redemption fee doesn’t end up costing you more in the long run.

Paying off the mortgage will also mean your inheritance money becomes tied up in your home, rather than as cash in the bank. You might decide that you’d rather have that money available if and when you need it – or want to use it for other financial goals, like topping up your pension.

As the pandemic showed, having an emergency fund available when you need it most can be a life-saver

Building up an emergency fund

Once your high-interest debts have been cleared, it’s wise to put some cash aside as an emergency fund. As the pandemic showed, having an emergency fund available when you need it most can be a life-saver.

Most financial planners recommend saving up to around three months of your average household income. This should be enough to cover any unexpected changes to your income, such as losing your job or other unforeseen events, although the amount you decide to hold may depend on your regular financial outgoings or the industry you work in.

Investing tax-efficiently

If you’re relatively new to investing, inheriting a lump sum could offer a great opportunity to build your investment portfolio. Most investors choose to invest via a Stocks & Shares Individual Savings Account (ISA) because any gains you make from your investment are free from tax. You can invest up to £20,000 into your ISA each year (in 2022/23), and choose whether to invest that money in funds, individual shares or investment trusts.

There are many other types of tax-efficient investments. The right option for you will depend on a range of factors including your investment goals, the level of risk you’re willing (and can afford) to take, and whether you’re looking for growth or income. Do remember that investing carries risk, and your investments can go down as well as up. You may not get back the full amount you invest.

For more, see 5 ways to make tax-efficient investments

Invest in your pension

Pensions are one of the most tax-efficient ways to put money aside for your future, not least because they come with financial incentives that encourage you to invest more for your retirement.

Taxpayers who make pension contributions receive 20% tax relief (effectively a free ‘top-up’ from the government) on the amounts they contribute. Higher-rate taxpayers can claim 40% relief, and additional-rate taxpayers can claim 45% pension tax relief.

If you decide to make a contribution to your pension, it’s important to know how much you’re allowed to pay in before triggering tax charges. For example, there’s an annual pension contribution limit of £40,000, and you can carry over any unused pension allowance from the previous three tax years.

There is also a pension lifetime allowance, which is the total amount you can pay into your pension before facing tax penalties. This lifetime allowance currently stands at £1,073,100 for 2022/23. Like any investment, pensions carry risk and their value can fall as well as rise.

For more on pensions, see Why a pension is a good starting point for your financial plan

You might want to leave an inheritance of your own, or gift your loved ones during your lifetime

Planning for your own legacy

If you’ve been fortunate enough to receive an inheritance that helps to improve your quality of life, you might want to leave an inheritance of your own, or gift your loved ones during your lifetime.

If so, it’s important to understand the potential implications of inheritance tax (IHT) on the value of your estate, and take steps to limit the charges your loved ones might need to pay. A financial planner can help by calculating the value of your estate (including any inheritance you’ve received), as well as determining the IHT bill that might be due upon your death.

They can also help by suggesting estate planning strategies. These might include setting up trusts, making gifts or charitable donations, or investing in ways that are exempt from IHT.
Remember, any assets you hold at the time of your death will form part of your estate and therefore be subject to IHT, so you may decide it’s better to spend more of it on you!

You might also be interested in Tax-efficient ways to leave a legacy

Enjoy spending on yourself

Getting your finances into shape might feel like the most important thing to do when you receive an inheritance, but don’t forget to enjoy yourself along the way. Provided the necessities are covered by your financial plan, it’s important to remember that life is for living. After all, someone special wanted you to have that money – so you shouldn’t feel guilty about making the most of it.

It’s almost impossible to list all the things you can do with a large inheritance. For some, it could mean buying a bigger house, a private education for your kids, the holiday of a lifetime, or getting the sports car you’ve always hankered after. It could mean making gifts to your family or donations to charity. What you do really does depend on your priorities here and now, and your ambitions for the future.

There have been significant changes to pension savings in the Spring Budget 2023 that may impact your retirement planning. To find out more, see: How does the 2023 Budget affect your pension and retirement planning?

Amber River Financial Planning

All over the UK, Amber River independent financial planners are helping people at different life stages focus on their financial wellbeing. We call it Life Landscaping®, because each individual’s journey is unique. To speak to one of our team or to arrange an appointment, call 0800 915 0000, or use our form to contact a financial planner.

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To speak to one of our team, arrange an appointment or find out more, call 0800 915 0000, or alternatively use our contact form here.