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

Parent Cafe
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<p>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!</p>

<p>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.</p>

<p>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. </p>

<p>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. </p>

<p>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 :)!</p>

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<p>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!”</p>

<p>Guess your hubby was not seriously injured, thank goodness!</p>

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<p>Depending on the wording of your settlement, it may not be taxable. Your accountant should be able to tell you. </p>

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

<p>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.</p>

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<p>Use the cash now or put the cash in a retirement plan and take a loan?</p>

<p>Pros & Cons:</p>

<p>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</p>

<p>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? </p>

<p>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?</p>

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<p>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).</p>

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<p>

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.</p>

<p>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.</p>

<p>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. </p>

<p>A bigger house or addition means higher property taxes too.</p>

<p>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.</p>

<p>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.</p>

<p>Free advice - worth every penny. :)</p>

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<p>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.</p>

<p>Wishing you all the best!</p>

<p>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!</p>

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<p>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.</p>

<p>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.</p>

<p>If you are adding the addition just for dealing with the money, I would suggest you rethink this.</p>

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<p>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)</p>

<p>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?</p>

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<p>IIRC, SEP contributions are capped at around 20% of income.</p>

<p>A Solo 401K would let you out even more away than a SIMPLE.</p>

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<p>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 ;)</p>

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<p>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%.</p>

<p>Talk to a professional, it will cost you but it will worth it.</p>

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<p>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!</p>

<p>Good luck with everything!</p>

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<p>I’d look into variable annuities. </p>

<p>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. </p>

<p>Its very confusing market but could be worthwhile.</p>

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<p>

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.</p>

<p>If neither is working, then you can’t contribute to an IRA.</p>

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<p>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…</p>

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<p>Thanks for all the advice. I truly appreciate all who have taken the time to reply.</p>

<p>notre dame AL - Thanks for asking about my H. Fortunately, H’s injuries were not life threatening, but the accident was very frightening. H and I were driving two separate cars to visit youngest D in a major east coast city. D was working a temporary job and at first believed she wouldn’t need her car with her. Ultimately, she decided she needed to have it, so, good old mom and dad had to bring it to her. We were driving just outside of the downtown area of “big city” in the center lane of a 3 lane east bound interstate highway. It was about 7:00 p. m. on a clear June day. Traffic was flowing smoothly and most drivers were actually obeying the 55 mph speed limit and not tail-gating. Amazing! Out of the corner of my eye, I saw a driver come speeding past me on my left. I’d say he was doing around 80 mph. I watched him sideswipe a lengthy rock wall supporting an overpass. That sent him careening across the highway toward the center lane and my H. At first, I thought that he was going to just miss hitting him. My H told me he heard something roaring behind him and instinctively tried to speed up. Unfortunately, the other driver hit H’s car on the rear driver’s side. The impact sent the two cars travelling parallel to each other and into the rock wall. Both cars rebounded off the rock wall and back toward the center of the road. It was like watching a horrific game of pinball. The other driver’s car was fishtailing all over the road and hit H’s car a second time. That hit sent H’s car travelling perpendicular to the highway and into a concrete barrier on the right side of the road. The other driver’s car came to a halt in the middle of the road facing the wrong way. Total: 2 strikes by other car, 1 impact head-on into rock wall, 1 impact head-on into concrete barrier. I honestly thought at the time that I was watching H’s death.</p>

<p>Miraculously, no one in the other driver’s car was injured. He had two passengers with him. I never found out what on earth he was doing at the time he lost control of his car. Texting?? No drugs or alcohol were involved.</p>

<p>H ended up with a torn rotator cuff and a shredded labrum in his right shoulder plus a back injury. We had a fun night in “big city” ER. We waited 11 hours for H to be seen by a doctor. The only thing he had for pain during all that time was an ice pack! The total food we had that night was a shared package of peanuts. We didn’t have any change for more snacks from the ER vending machines. The cafeteria was closed until we were finally ready to leave at 6:30 a.m… H is a diabetic, so that wasn’t exactly a good situation! We joked with the resident who finally examined him that we could have literally driven back home in the time that we waited in the ER. (We were exactly 11 hours into our trip when the accident occured.) Moral, never go to a downtown big city ER on a Friday night! </p>

<p>H had surgery for the shoulder injuries after we returned home. H considered his shoulder injury to be more pressing than his back injury. He lived with back pain from spinal stenosis for many years before having surgery 3 years ago. The accident caused swelling and irritation in the nerves in H’s back bringing back the pain his surgery had alleviated. His surgeon decided to try PT, which only helped a little. In late May of this year the problem worsened. H now has extreme weakness in his right leg and has actually fallen several times. He can’t use his right leg to go up stairs at all. Walking is painful. He’s using a cane for support. New tests have determined that he has a ruptured disc and needs surgery. The surgeon has told him that recovery will be much more difficult than the recovery from his surgery 3 years ago. He’s told him that it may take up to a year before he’ll be functioning as well as before the accident. So, even though we are settling with our insurance company, the physical consequences of the accident aren’t really over.</p>

<p>H and I will be consulting a financial professional about what to do with the settlement money, but of course, the final decision will be up to us. Naturally, we realize that the smartest financial decision would be to invest all of the settlement money and continue to save as much money as possible. But, we are fairly sure that we are going to put an addition onto the house. We would not be doing the remodel as a way to deal with the settlement money. LOL! Our current tiny home is completely paid for, but we have no room to host the big family get-togethers that our relatives enjoy. We believe that we can afford to build the addition we’ve always wanted and still have enough to comfortably retire if our investments return a modest 7%. We’ve been fortunate to have earned nearly 18% on our investments in the past 14 months and have managed to accrue about $150,000. That’s in addition to H’s pension. My reading tells me that a 7% return is a reasonable expectation for our mutual funds and that we really should need less than 100% of our current income, adjusted for 3% inflation per year. I have figured that H’s pension plus our investments should give us a retirement income equal to 100% of what we currently live on. </p>

<p>Notrichenough and Happymomof1, I will check with a professional on the rules for spousal IRAs. I did a lot of research when I set up my SIMPLE and my understanding was that if the non-working spouse was drawing any type of retirement benefit, money could not be placed in an IRA for him or her. (My husband retired from teaching 10 years ago because of a chronic medical condition. He draws a pension.)</p>

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<p>For non taxable income (or after tax income) you should contribute to Roth IRA, Traditional IRA is for the before tax income. To your 100K, it is over the annual limit for any IRA contributions.</p>

<p>btw, you do not have a tax problem as the settlement is not taxable, you just need investment advise or financial planning.</p>

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<p>Wait a minute…How many years do you have to invest your money?</p>

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</p>

<p>7% return is pretty hefty and carries significant risk to loss of principal. Can you also afford a -20% return on your investment?</p>

<p>I would invest in the stock market only if you have at least 5 and preferrably more than 10 years before you need the money.</p>

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<p>

It depends on the IRA type and whether you are covered by another retirement plan.</p>

<p>For married filing joint and covered by a retirement plan, if your modified AGI is under $89,000 you can deduct a regular IRA contribution in full, the deduction phases out from $89K-$109K.</p>

<p>For a Roth IRA, your modified AGI has to be under $167,000, and the ability to make a contribution phases out between $167K and $177K.</p>

<p>Here’s a nice summary with charts that shows all the combinations: [IRA</a> Contribution Limits](<a href=“http://www.money-zine.com/Financial-Planning/Retirement/IRA-Contribution-Limits/]IRA”>IRA Contribution Limits in 2020 and 2021)</p>