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Help! How do I handle tax consequences of Insurance settlement (long)

FinancialnoviceFinancialnovice Registered User Posts: 4 New Member
edited October 2010 in Parent Cafe
I am hoping that the brain trust at CC can help me. I am using an alternate posting name today because too many people in my town have figured out who I am under my usual posting name!

My husband will shortly be receiving a $108,000 settlement check for injuries received in an auto accident. I do know that none of the money that my husband receives for his injuries carries any tax liability. We would like to invest the money, but we are unsure how to best deal with the tax consequences of any profit we make on the investment.

I am self-employed and my husband is retired. Because H is retired, we can’t put any money into an IRA for him. I opened a SIMPLE IRA 14 months ago and had planned to sock $12,000 per year into it for the next 14 years, then retire. I picked a SIMPLE rather than a traditional or Roth IRA because the government allows me to put as much as $14,000 per year into it. The SIMPLE is tax-deferred like a traditional IRA. I have used some online calculators and have learned that whether I invest money in my SIMPLE over the next 14 years, or I just add the $108,000 windfall to the money we have already invested and do not save another penny, we’ll have just about the same amount of money when I plan to retire. If we manage to garner a 7% return and inflation is 3% a year, we’ll be able to have as much money in retirement as we currently have now. The money should last until I’m in my 90s. My H’s pension and my very modest income total about $50,000 a year. We currently have no debt. We have wanted to either build an addition onto our very modest house, or move to a newer, larger home for years. But, the money just always seemed to be needed for our kids. Now it looks like we may be able to finally to get a bigger house. My thinking is that maybe we should invest the insurance money and take out a loan for 10 to 15 years to pay for the new house. BUT, I don’t know if that’s the best course of action.

Would we be better off to pay for the new house in cash and put the maximum into a Roth IRA and another $6000 per year into my SIMPLE? I worry about having a huge tax bill that we’ll be hard pressed to pay if I invest the insurance money into mutual funds and lose the tax break I get for putting a lot of my income into the SIMPLE. Plus, I worry about the increase in my property tax bill that will come along with a bigger home.

Do any of you have any suggestions about how to handle the tax consequences before I speak to a tax attorney? I’d be very grateful for any advice you have. I figure that several CC heads are better than my H’s and mine plus one attorney :)!
Post edited by Financialnovice on

Replies to: Help! How do I handle tax consequences of Insurance settlement (long)

  • notre dame ALnotre dame AL Registered User Posts: 1,674 Senior Member
    An attorney will best be able to advise you; if it is free advice that you are searching for, you will "get what you pay for!"

    Guess your hubby was not seriously injured, thank goodness!
  • dmd77dmd77 Registered User Posts: 8,663 Senior Member
    Depending on the wording of your settlement, it may not be taxable. Your accountant should be able to tell you.

    (Sorry, just reread and saw that you know that the settlement itself is not taxable.)

    Any money you make by investing that money will have the same tax consequences as any other investment. If you put it in the stock market, you'll have to pay capital gains tax. If you put it in a Roth IRA, no taxes. If you put it in a regular IRA, taxes. If you put it in real estate, you can exclude your gains, if any. Etc. From the POV of the IRS... it's just money.
  • somemomsomemom Registered User Posts: 10,441 Senior Member
    Use the cash now or put the cash in a retirement plan and take a loan?

    Pros & Cons:

    Investing the $ forces you to save it, if you don't put it in now, despite your plans, there could be a year when you cannot or do not choose to invest the max in your retirement

    What interest will you pay on a loan versus what will you earn on a retirement plan? Is the interest you earn tax free? In an Roth IRA the interest is tax free, in an old IRA it is tax deferred. What is it for a SIMPLE?

    If it is not taxable income then there is no tax benefit to putting it in a regular IRA, right? You have been reducing your taxable income by the SIMPLE deposit, so how will that affect you tax wise if you no longer have that deduction?
  • artloversplusartloversplus Registered User Posts: 7,919 Senior Member
    If you are worried taxes on income from the investment, the best advise is to buy tax exampt bonds. Believe me or not, they are paying about 3% or more, lot better than the 5 year cd paying. The risk of the investment of course is in its principal fluctuataion. Details of it you should discuss with your investment advisor(s).
  • notrichenoughnotrichenough Registered User Posts: 7,933 Senior Member
    Because H is retired, we can’t put any money into an IRA for him.
    Even though retired, I believe a non-working spouse can put up to $5000 ($6000 if over 50) in a deductible IRA as long as the working spouse makes at least that much and less than $167,000 or so (it starts to phase out if the spouse makes more). Or you can also put money into a Roth IRA (with the same limits) - you can't deduct it but future earnings are tax free of course.

    Based on $50K/year in income, you are in the 15% tax bracket, so not putting $6000 in your SIMPLE will cost you around $900 in Federal taxes plus whatever you will pay in state taxes. Since you anticipate having about the same income when you retire (and probably around the same tax rate as now), there doesn't seem like a compelling choice between the SIMPLE and a Roth.

    As for taking a mortgage - right now rates are around 4%. I'm guessing you don't itemize, so you get no tax savings from paying interest. You will need to make 4% or higher to make having a mortgage be the better choice. Right now, that is impossible to do without some risk.

    A bigger house or addition means higher property taxes too.

    Moving sucks a lot, but major renovations are no picnic either. If you add an addition, you need to have the energy to stay on top of it. There are many unscrupulous contractors out there.

    The smartest financial choice is not put on an addition or buy another house, of course. Whether the space is worth it only you can say.

    Free advice - worth every penny. :)
  • happymomof1happymomof1 Registered User Posts: 25,327 Senior Member
    Did you check out the rules for a SEP IRA? I've never set up a SIMPLE, but I have set up a SEP for myself and another for my husband at times that we had self-employment income. The amount you can deposit in a SEP IRA has a maximum that depends on your earned income, but in addition to the SEP (which serves the place of a company pension plan or 401k), you can still max out on your personal IRA either as a Traditional or Roth IRA. That strategy might let you put more money away faster.

    Wishing you all the best!

    added after reading notrichenough: Your husband can put the max each year into his own IRA (either Traditional or Roth) because he's married to you, and you have earned income. Do run that through your calculator too!
  • thumper1thumper1 Registered User Posts: 63,411 Senior Member
    I don't know the size of your house, but as we anticipate retirement around this house...we WISH we had the smaller house we used to own. We do NOT need all of this extra space for two of us...never mind the utilities and taxes it takes to operate the place.

    I guess if it were me, I'd do some remodeling of my smaller home (if you like the location) and enjoy it. As above...only YOU can make the decision of whether extra space is important to you.

    If you are adding the addition just for dealing with the money, I would suggest you rethink this.
  • somemomsomemom Registered User Posts: 10,441 Senior Member
    I agree with Thumper, we downsized, too. Also, depending on the scope of the fix up job, your remodel may not add to your tax bill (and according to permitting rules in your community)

    And like HM, we use a SEP not SIMPLE. You might ask the accountant how much of you current income you would be allowed to SEP...if you live on the insurance money and SEP every penny you are allowed, would that work?
  • notrichenoughnotrichenough Registered User Posts: 7,933 Senior Member
    IIRC, SEP contributions are capped at around 20% of income.

    A Solo 401K would let you out even more away than a SIMPLE.
  • somemomsomemom Registered User Posts: 10,441 Senior Member
    Based on the money we put into a pension in the mid 80s which rolled into a special IRA and has benefit from compounding all these years, if I got $100k, I'd pay down/off the mortgage ;)
  • artloversplusartloversplus Registered User Posts: 7,919 Senior Member
    Now a days if you get 7% return you will be take on a lot of risk. I do that as a profession, so I am aware of the investment community. Either you cannot have the additon or you need to live with about 3%.

    Talk to a professional, it will cost you but it will worth it.
  • happymomof1happymomof1 Registered User Posts: 25,327 Senior Member
    Hmm. I need to check up that rule about no longer being able to pay into an IRA once you begin to draw a pension. Maybe that is so. Although it hardly makes sense when many people return to work and have earned income from JobB even though they are formally pensioned off from JobA! Thanks for giving me something new to find out about!

    Good luck with everything!
  • LongPrimeLongPrime - Posts: 5,208 Senior Member
    I'd look into variable annuities.

    I discovered that there many types of annuities, the agent will prefer one type over another. Some insurance companies will have variation of the same type depending on which outlet they are selling thru.

    Its very confusing market but could be worthwhile.
  • notrichenoughnotrichenough Registered User Posts: 7,933 Senior Member
    I need to check up that rule about no longer being able to pay into an IRA once you begin to draw a pension.
    AFAIK, as long as one of you is working and has enough earned income to fund the IRA contributions, you can contribute, even if the other is retired and drawing a pension.

    If neither is working, then you can't contribute to an IRA.
  • aibarraibarr Registered User Posts: 4,249 Senior Member
    I know nothing about tax consequences of insurance settlements, but thank heavens you all are okay! What a terrible ordeal... Sending my best wishes that your husband's back surgery goes well and that his continued recovery goes smoothly...
This discussion has been closed.