Investing your inheritance: what should you do with it?

Investing an inheritance is a significant financial decision that requires careful consideration and planning. Learning how to manage inherited wealth effectively can make the difference between a windfall that's frittered away and one that genuinely improves your long-term financial position.

While the initial situation and amount of money inherited may come as a surprise and arrive suddenly, it is important to keep a level head, strip out sentimentality, and focus on making the most of your new-found wealth. 

We reveal some general steps to guide you in the process.

Evaluate your financial situation and financial goals

Receiving an inheritance can come with mixed feelings. It’s a sad time, but the amount you receive can also be life-changing.

It could help you get on the property ladder, pay off debt or boost your long-term savings. But knowing what to do with a large inheritance sum can also be daunting.

It’s worth taking your time to make the right decisions. If you’ve inherited a substantial amount then a financial adviser can help you invest in the best way to achieve your financial goals.

Determine your short-term and long-term financial goals.

These goals may include buying a house, saving for retirement, paying off debts, or funding education.

Here’s a summary of potential financial priorities to consider when you inherit.

Create an emergency fund 

Before investing, set aside an emergency fund with three to six months' worth of living expenses.

This ensures you have a financial safety net in case of unexpected expenses or job loss.

To minimise the chances of needing to use your emergency fund, assess your risk tolerance, which is your ability to handle market fluctuations and potential investment losses – a financial adviser will be able to help.  

Pay off high-interest debts 

As previously suggested, your debts will likely be linked to your age and life stage and may include a student loan, mortgage, other home loans, credit card debt or other high-interest amounts. 

If you have any high-interest debts, consider using a portion of the inheritance to pay them off.

This can help improve your financial situation and reduce interest payments.

Interest on debt is often much higher than on savings or lower-risk investments.

It makes little sense to open an ISA, for example, and invest in a fund with a 4.5% return, while also having outstanding credit card debt with an interest rate four times higher. 

Establish an investment plan 

Having financial eggs in several baskets is a good idea if you’re new to investing or have a limited amount to invest.

If this is your first time, determine the right investment strategy based on your goals, risk tolerance, and life stage.

There's no single best way to invest an inheritance, as the right approach depends entirely on your personal circumstances, but spreading risk and matching investments to your timeframe are good starting principles.

To spread the risk, consider diversifying your investments across different asset classes, such as stocks, bonds, property, and other investment funds. 

Educate yourself 

You’re taking the first step to investing inheritance money well by reading this guide.

Take the time to educate yourself about investment options, market trends, and investment strategies appropriate to your situation.

Understanding the basics of investing will empower you to make informed decisions and potentially achieve better results.

A financial adviser will consider your situation and discuss your goals, and your available options. 

Start investing gradually and remain patient 

There are several good reasons to take a gradual approach rather than diving in head-first, including sentimental reasons attached to inheriting money.

It’s difficult, but try not to be swayed by what you think the benefactor would have wanted.

Market conditions may have changed, and your situation may not match their wishes.  

So, rather than investing the entire inheritance at once, consider a gradual approach.

This technique involves investing a regular, fixed amount, regardless of market conditions and can help mitigate the impact of market volatility. 

Investing is a long-term endeavour, and it's important to remain patient and avoid making impulsive decisions based on short-term market fluctuations.

Stay focused on your goals and maintain a disciplined approach. 

Monitor and adjust your investments 

Unless you have chosen a financial adviser to manage your savings and investments, you must regularly review your investment portfolio and adjust as needed.

Market conditions and your financial goals may change over time, so it's essential to stay informed and adapt your inheritance investment options accordingly.  

Ensure you put specific dates in the diary to review your investment performance and adjust accordingly. 

How can I protect my inheritance from tax

Inheritance tax is a common worry for beneficiaries. But it is handled and paid by executors before the inheritance is paid out. Instead, your focus should be on potential future taxes on your cash and investments.

Investments are subject to capital gains tax and dividend tax, while savers are charged income tax on interest.

Here, both ISAs and pensions are great options as they protect your investments from capital gains tax, dividend tax and tax on interest. But they also have different pros and cons. Here’s a summary of how they compare.

Consider paying into an ISA

Investing inside an ISA can be a great way to protect your investments or cash from tax. 

Any gains made on shares held inside an ISA are exempt from capital gains tax (CGT). Read more here to find out more about how CGT works. 

Cash held inside an ISA or pension is also protected from tax on any interest. 

You can contribute up to £20,000 each tax year to an ISA. You can’t carry forward any unused allowance, so it’s important to make the most of your allowance each year.

Consider contributing more to your pension

Investing in your workplace pension or a private pension, such as a self-invested personal pension (SIPP), is also a great option for an inheritance. Like an ISA, investments made inside a pension are protected from CGT.

You’ll also receive tax relief on any pension contributions. Basic rate taxpayers receive a £20 boost for every £80 they contribute, whereas higher rate taxpayers receive £40 on top for a £60 contribution.

Pension contributions are capped at £60,000 in any tax year (known as the pension allowance), or your earnings, whichever is higher.

You can also carry forward any unused pension allowance from the previous three tax years, although you still can’t pay in more than you earn in the current tax year.

Watch out, because your workplace pension and any tax relief are also counted as part of your allowance. For example, if you earn £50,000 in the current tax year, you can pay £50,000 into a pension, including tax relief and employer contributions.

If you’re a higher earner, then you may be able to contribute up to £60,000 to your pension and £20,000 to your ISA in one tax year.

If you’re investing inside an ISA or pension, you’ll still need to decide how to invest. Some providers offer ready-made funds based on your risk profile or financial circumstances.

Common mistakes when investing an inheritance

Even the best intentions can unravel when decisions are driven by emotion rather than strategy.

Below are the pitfalls that most commonly chip away at an inheritance's long-term value.

Spending too quickly

It's easy to start dipping into the money straight away without keeping track of where it's going. Impulse purchases or lifestyle upgrades can erode the amount far faster than expected.

Taking the time to define your financial priorities first helps the inheritance serve a genuine purpose, rather than disappearing into everyday spending.

Keeping the previous owner's investments unchanged

Inherited investments often reflect someone else's financial goals and risk tolerance, not yours.

Leaving a portfolio exactly as it was can leave you exposed to risks or asset classes that no longer suit your situation.

Review each holding carefully and decide what actually supports your own goals, rather than assuming the existing approach is right for you.

Overlooking tax implications

Different assets are taxed differently, and interest, dividends and capital gains from inherited investments or accounts may all be treated separately.

Check how each applies to your circumstances before selling or reinvesting, so you don't lose more than necessary to tax further down the line.

Taking on too much risk

A sudden windfall can bring a false sense of confidence, leading some people to invest more aggressively than they normally would, on the assumption that losses can easily be recovered.

A balanced approach that matches your goals and timeframe is far more likely to preserve the value of your inheritance over the long term.

Ignoring how it affects your wider finances

An inheritance can change your entire financial picture, from your pension planning and tax bracket to your eligibility for means-tested benefits.

Reassessing your finances after a significant life event like this helps keep your plans realistic and aligned with your new circumstances, rather than carrying on as before.

Seek expert investment and pension advice 

Arrange an initial meeting with a financial adviser who can provide personalised guidance based on your specific circumstances.

They can help you develop a suitable investment plan, select appropriate investments, and monitor your portfolio over time.

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