Inherited money? 7 expert tips for your windfall

Receiving an inheritance often brings mixed feelings. A financial windfall can be exciting, but also overwhelming, especially at a time when you’re grieving the loss of a loved one. That can make deciding how to use it all the more difficult.

The best way to spend an inheritance will be different for everyone. This guide helps you consider your options, from the best ways to invest to passing it to children or grandchildren in the most tax-efficient way.

What’s on this page?

• Don’t rush your decisions
• Pay off debts
• Build a safety net
• Invest tax-efficiently
• Top up your pension
• How to pass the inheritance to children or grandchildren

Don’t rush your decisions

Receiving an inheritance can be an emotional experience. While some time may have passed since the death, you might still be grieving. You might feel pressure to make swift decisions about the money, but financial experts often advise taking a step back.

It’s fine to allow yourself time to grieve without the added stress of major financial planning. A practical first step is to place the funds in an easy-access savings account, ideally one paying a competitive rate of interest.

This keeps the money safe and allows it to earn some interest while you take the time you need to think clearly. Giving yourself a few months, or as long as you need, before making any significant choices can help to give you clarity about your priorities.

The exception might be if you want to transfer the inheritance to someone else – more on this below. Of course, it’s OK to spend some of it on luxuries or treat yourself to a holiday. As Daniel Hough, wealth manager at RBC Brewin Dolphin, puts it: “If you receive an inheritance, upgrade your standard of living while you can, especially when you are fit and healthy, as there will undoubtedly come a time where long-haul travel or an active life won’t be practical any more.”

This is also a time when you should look carefully at your financial situation, as using a windfall wisely can also help you pay off debts, boost your retirement savings or allow you to help your family.

According to a survey by Hargreaves Lansdown, many people say they would be sensible if they received a significant inheritance, with 53% of respondents saying they’d save at least some of it, 27% would invest it while 17% would put the money into their pension.

Pay off debts

Paying off expensive debts should be a priority when it comes to spending your inheritance. For example, any credit card balances incurring interest, store cards or personal loans. According to David Little, partner in financial planning at wealth management firm Evelyn Partners, clearing these debts “equates to a guaranteed return and reduces financial stress”.

Once you’ve done that, you could look at overpaying, or clearing, your mortgage – if you haven’t yet repaid it. But do watch out for early repayment fees. It could be better to overpay up to the penalty-free limit (often 10% of the remaining mortgage each year), and put the rest in a high-interest savings account.

If you’re nearing the end of your mortgage deal, you may be able to overpay larger amounts in the final month of your deal. Check with your lender what early repayment fees there are, and what you can do without incurring fees, so you can make an informed decision.

Build a safety net

The next thing to think about is building an emergency savings buffer. This money is helpful if you come up against some unexpected expenses, whether that’s the boiler or car breaking down, or you need surgery and want to pay privately to avoid NHS waiting lists.

It’s recommended to have at least six months’ worth of living expenses in easy-access savings, in case anything unexpected happens. If you are already retired and living off pensions, it is often recommended to have a larger buffer of one to three years expenses. Use an easy-access savings account or cash ISA to hold this money so you can withdraw it

Invest tax-efficiently

If you’ve cleared expensive debts and got your savings buffer in place, you might want to consider investing your inheritance in the stock market. Little says: “A smart money decision is to invest using tax allowances. Long-term investing, when the tax is optimised correctly, provides financial security.”

Over time, investing will usually grow your wealth faster than leaving your money in a savings account. However, you do have to accept some risk (investments can go down as well as up), and you’ll need to be happy to invest for the long term – at least five years is usually recommended.

If you want to find out more, we have lots of tips and information in our beginners’ investing series.

You can avoid having the taxman take a cut of your investment returns by using a stocks and shares ISA. Each year you can contribute up to £20,000 and you’ll pay no tax on investment growth or withdrawals.

If you’ve already used your annual ISA allowance, or your inheritance is more than your allowance, you could pay some of the inheritance into a general investment account. This is taxable, but you still benefit from the capital gains tax allowance (earn up to £3,000 a year tax-free) and the dividend allowance (up to £500 a year).

Top up your pension

Using an inheritance to top up your pension can be a good choice, as you could get free cash from the government in the form of tax relief. The government adds 20% tax relief if you’re a non or basic-rate taxpayer – making an £8 contribution worth £10 in your pension. This rises to 40% relief for a higher-rate taxpayer, and 45% for additional-rate taxpayers.

Be aware that if you pay higher or additional rate tax, you may need to complete a tax return to ensure you get the full rate of relief that you are entitled to (some schemes will only pay basic rate tax relief automatically).

Plus, you can access your pension from age 55 (rising to 57 in 2028), so you may be able to access the money soon, if not already. Little comments: “Pensions are often overlooked, despite the significant tax advantages. Pensions grow tax-free and the tax relief can make a huge difference over the longer term.”

Most people can contribute 100% of their earnings up to £60,000 a year. 

If you have no earnings (pension income and buy-to-let income don’t count as earnings in this case) you can still contribute up to £2,880 a year and get 20% tax relief, bumping your total contribution up to £3,600.

But watch out if you have already accessed your pension, as the £60,000 allowance may drop to just £10,000. This is known as the money purchase annual allowance, and can be triggered once you have made a taxable withdrawal from your pension. If you have only taken tax-free cash or bought an annuity, you may still benefit from the full £60,000 allowance.

According to Hough, this lower £10,000 limit is designed to prevent abuse of the system, where savers recycle their contributions. In other words, they withdraw money then pay money back in to gain further tax relief.

How to pass the inheritance to children or grandchildren

If you don’t need the money or are already facing a potential inheritance tax (IHT) bill on your own estate, you may wish to pass the inheritance to your children or grandchildren. There are two main ways to do this.

The first is a deed of variation. Gemma Hughes, partner and head of the private client team at law firm Mackrell, explains: “This is a legal document that can be used to change the terms of the will so that some or all of someone’s inheritance can be redirected to someone else – an existing beneficiary under the will or an entirely new one.”

The executor of the will can arrange this, and it needs to be done within two years of the date of death. A deed of variation will keep the money away from your ownership and, as a result, your estate.

The other option is to take the inheritance, then gift it. Little explains: “This will be classed as a ‘potentially exempt transfer’ on your estate – therefore you will need to survive seven years from the gifting date for it to fall outside your own estate. It’s a simpler option, but carries the risk of increasing your own IHT liability.”

Hughes advises doing a “deed of gift”, a legal document that records the transfer, in case it is required in the future.

Hough at RBC Brewin Dolphin says that receiving an inheritance is a good time to think about your own legacy and estate.

“Look at gifting money to family, friends or charities. There are rules around annual allowances and timescales for gifts to become exempt from IHT, so best to start early,” he says. “Take care to ensure that you have enough money left to meet your own financial needs, and consider taking financial advice.”