Author Topic: Windfalls and IRAs  (Read 1964 times)

TheMoviegoer

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Windfalls and IRAs
« on: January 26, 2014, 12:20:55 PM »
Hi everyone,

I'm a 22 year old guy making mid-50s a year, just graduated school. Due to a death in the family I am receiving about $10,000. I need help deciding whether to invest this in an IRA (and, if so, traditional or Roth) or a taxable account.

Current financial landscape--
Traditional 401k -- $3000 (automatic 23% into this)
Taxable -- $17,000, mostly from saving growing up / extra scholarship money (all invested in individual stocks and index funds, but I'm looking to invest solely in index funds in the future and limit the risk of the portfolio with bonds)

No IRA or Roth IRA.

There are 3 options I see:
1) Invest $5500 in traditional IRA, which would put me up to the limit in 2014 and (I think) get me a sizable tax refund in early 2015. This would also put me right at the edge of the 25% tax bracket, and I would avoid the 5% state income tax. BUT isn't this eventually double-taxing the money since taxes were already paid on it by my deceased family member?
2) Invest $5500 in Roth IRA--better for retirement maybe, but no extra investable tax savings this year due to it.
3) Invest all in taxable account for home down payments / family / etc.

In scenarios 1 and 2, I would invest the rest in a taxable account (index funds bought monthly).

I would appreciate some thoughts, particularly on the traditional vs Roth IRA and tax savings now vs in retirement.

Thanks!

Edited: No debts of any kind.
« Last Edit: January 26, 2014, 12:24:30 PM by TheMoviegoer »

Frankies Girl

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Re: Windfalls and IRAs
« Reply #1 on: January 26, 2014, 12:34:41 PM »
Not sure you can do a traditional with inherited cash since technically the taxes have already been paid on that amount. I would probably put it into a Roth IRA (after tax) and you can contribute 11K ($5,500 for 2013, same for 2014) if you do the contributions before April to get the 2013 contribution.

In my experience, you don't pay taxes on a cash inheritance; that is paid through the estate if there is anything owed, and if you were left a sum of money, then it is yours and would have already had taxes taken out. Of course, I have only my experience to go by, so you'd need to double check through the IRS or the like, but we inherited the sum of $25K through a family friend that left that to my husband a while back, and the IRS said that no taxes were owed by us at the time (it's not income either). And I inherited a substantial amount of cash money from my dad recently, and same thing again. If it is inherited in an account like an IRA, then there could be taxes needed to be taken out if you want to access the funds, but you can contact the brokerage holding the account for details on that aspect.

Not sure why you say you'd need to buy index funds monthly - you can just open the Roth and put in the money, and buy index funds all right then, and with the amount over 10K, you can probably get the admiral shares since that's usually the minimum investment amount.

Tax wise, you'd probably do better at increasing your 401K contributions to lower your overall income if you're right on the cusp of being in one or the other tax bracket.
« Last Edit: January 26, 2014, 12:36:21 PM by Frankies Girl »

TheMoviegoer

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Re: Windfalls and IRAs
« Reply #2 on: January 26, 2014, 12:45:03 PM »
Thanks for the reply.

I believe you can do traditional with inherited money. As far as I can tell, you need to have earned compensation to quality for deductible contributions, but the contributions themselves do not have to be the earned income itself (I think). If that is not the case, then there is a way around it--keeping the inherited cash and directing the entirety of a few paychecks to a traditional IRA.

I'm not concerned with estate taxes (the estate was too small), but whether by the methods above I should lower my taxable income, by investing more into a traditional IRA than I would ordinarily be able to without the windfall, or put the money into a Roth.

(Also, buying index funds monthly would be to dollar cost average over the course of a year. Am I misunderstanding that concept? Trying to avoid putting all my money at a peak.)


-- Agreed about pushing myself into the 15% bracket. I don't like the funds in my 401k, so I'd prefer a Vanguard IRA.
« Last Edit: January 26, 2014, 12:52:32 PM by TheMoviegoer »