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Investing an inheritance

originally posted: 8/15/2014   revised:


Q: I have some inheritance coming my way. Ideally, I would like to take a portion of the money to pay off outstanding debt and a portion set aside in an account that would give me:

  1. tax shelter
  2. non-penalty access (or low)
  3. investment growth
I would like to avoid a big tax bill next year. I have children and a spouse. Is my ideal list available as an investment option?


A: It sounds like you are on the right track. I would add these three comments:

1) Regarding investment choices: No single investment contains an ideal mix of all of the three features you need. One benefit is derived at the expense of others. So the best solution will likely involve diversifying among a few choices, each “specializing” in one purpose. If you take a portfolio approach then a portion of the money will meet each specific purpose: liquidity, tax efficiency, growth.

2) Regarding investment advice: The investment community’s typical fee structure works against your named goals. For example, a bank or insurance product that offers great tax shelter typically also included provisions to restrict access and reduce overall return. So this leaves you with two alternatives if you want additional help: go it alone or use an independent fee-only adviser.

3) Regarding tax planning: Tax planning is best approached using the “what it” tools built into today’s tax preparation software. This makes tax planning work simply and goes hand-in-hand with the tax return preparation. In other words, I doesn’t make sense discussing tax impact of future investments until we understand your current situation: the controlling factors and limitations of your current tax situation and the marginal tax rates. So I would start by looking at your past tax preparation method (do-it-yourself, online software, CPA, etc.) and ask whether this makes sense for the future given new tax planning needs. You might conclude that now is the best time (rather than waiting until next spring) to upgrade your tax return preparation method. Also, don't forget to consider that your plan to pay off debt may also have tax implications so this should be plugged into the tax planning calculation now using various "what if" scenarios to come up with the best overall approach. I suspect that if you follow this approach you will reduce taxes and that your new tax-saving strategy will not be limited to only the investment choices of your new inheritance.

"No single investment contains an ideal mix of all of the three features you need".

More resources:

  1. Tax planning checklist
  2. Top ten tax savings opportunities
  3. Develop your own personal investment policy