If you inherit a large lump sum of money deciding what to do with it can be an overwhelming task.

Should you pay off your debts or save for the future? Which tax wrappers and investments should you opt for?

It’s a nice problem to have, but making the wrong choices could result in the legacy of your loved ones dwindling away.

Deal with debt

Paying off debts should be one of the first things you consider. Austin Broad, group head of advice at AFH Wealth Management, suggests listing all your debts in order of the annual percentage rate (APR) and working down from highest to lowest.

‘Credit and store cards are most likely to carry the highest cost and should be dealt with as priority.  It is also important to understand the value of the interest rebate on early loan repayments as this can vary considerably,’ Broad says.

Interest rates on mortgages are at record lows so you might be tempted to maintain your mortgage and attempt to earn a higher return on an investment.

This is a risky strategy. Mortgage interest rates could go up in the future and your investments might not perform in the way you hoped.

‘Reducing or eradicating your debt burden provides you with certainty whereas there is always the possibility of losing capital through investment, so paying off debts may be preferred. The emotional impact of debt also has to be factored in,’ says Alex Brown, wealth management director at Mattioli Woods.

Build a cash buffer

Once you’ve thought about paying off debts, you should look at how much cash you have. If you haven’t got accessible cash savings you should keep some money aside to use for short-term emergencies, holidays, a new car, and so on.

‘Even though savings rates are generally very poor, the advantage of keeping money in cash savings is that you know it will be there when you need it,’ explains Patrick Connolly, head of communications at financial advice firm Chase de Vere.

Invest in the market

If you’ve got any money left over you could invest it in the stock market. A good place to start is with an ISA, which lets you invest in a range of funds and shares while maintaining instant access to your money.

‘From April 2017 the annual investment allowance increases to £20,000, up from £15,240 today, so if none of that allowance has been used £35,240 can be put into a tax-efficient savings product over the next few months. There is then no income or capital gains tax to pay either within the ISA or when money is withdrawn,’ says Charlie Musson, spokesperson for AJ Bell.

It’s also worth considering paying into a pension, as long as you don’t need the money until age 55. You can pay the equivalent of your earnings into a pension each year, up to a maximum of £40,000. If you’re a basic rate taxpayer you’ll get 20% income tax relief and if you’re a higher-rate taxpayer you’ll get 40% tax relief.

There is no income or capital gains tax to pay while money is held within a pension but income tax is due on withdrawals.

Identify your goals

Regardless of which tax wrapper you use, you’ll need to think carefully about which underlying investments you put your money into. Your choices will depend on how much risk you’re prepared to accept, what your goals are and how long you intend to hold the investment.

‘If they are investing over the long term (at least 10 years) and are prepared to accept some volatility along the way, then stock market investments may be worth considering. If their time frame is shorter than that or they would not be comfortable with short-term losses then cash or fixed interest investments may be more appropriate,’ explains Musson.

If it’s your first foray into investing you’ll probably feel more comfortable choosing funds rather than individual stocks. AFH’s Austin Broad suggests opting for a passive fund like an exchange-traded fund (ETF), which will track a specific index or part of a market, providing natural diversification.

You could consider a passive multi-asset fund, such as Vanguard’s LifeStrategy range of funds. These are diversified across different asset classes and you can choose the equity weighting that best matches your needs. They have a low annual charge of 0.24%.

For pure equity exposure, Musson suggests opting for a fund with a global remit and a good long-term performance record, such as Fundsmith Equity (GB00B41YBW71). The fund has a three-year annualised return of 22.6%. Its highest geographical exposure is the US and it invests in stocks like Microsoft (MSFT:NDQ), PayPal (PYPL:NDQ) and PepsiCo (PEP:NYSE).

An alternative is Scottish Mortgage (SMT), a global investment trust whose portfolio includes Amazon (AMZN:NDQ), Facebook (FB:NDQ) and Tesla Motors (TSLA:NDQ).

Create a balance

A good investment approach is to put your money in a balanced portfolio of shares, fixed interest and commercial property. You could also consider absolute return funds, which aim to make a profit regardless of stock market performance.

‘A portfolio of 40% shares, 30% fixed interest, 20% absolute return and 10% commercial property would be a good mix for balanced risk investors,’ says Connolly.

You might feel nervous about investing your entire lump sum at once. Investing it gradually over a year will dampen losses if markets are volatile, but your long-term return is likely to be lower.

‘Once the level of appropriate investment risk to take has been agreed, research would suggest maximum returns will be delivered by investing in a diversified portfolio immediately,’ says AFH’s Austin Broad.

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