Inheritance Received / Retirement Advice Needed

[newgolddream]

Hello all-

I've been a long time lurker here, and have enjoyed reading your posts for some time. I've recently arrived at a point in my life when it is time to make financial decisions for my retirement. I wanted to lay out my plan and ask your advice in pointing out any flaws or making any suggestions.

I'm 25 years old, making about $23,000 a year, working full time while attending college at night. My company offers a 6% match on the 401K, so that is what I contribute each paycheck. I recently received a substantial inheritance from my great aunt who I never knew. She passed some time ago, but for the longest time the money was wrapped up in some odd real estate deals I honestly don't know much about. None of that matters now, as the inheritance has been released to me. My father has allowed me $30,000 of this inheritance to begin investing. I already have an account open with GMAC which I've been putting bits of my paycheck in. I'd like to move this $30,000 into that account, and in the mean time use a part of that to start a Roth IRA with Vanguard, investing in their Target Retirement 2045 fund.

I have no debt. I own my car and home free and clear. I am single and have no expenses outside school, food, the light bill, and a serious penchant for collecting fountain pens . My dad will be handling the rest of the inheritance in various CD's and such until I can prove that all the stuff I've learned reading forums on the internet and listening to Clark Howard can pay off .

My biggest questions are:

1) Can I have both a 401k and a Roth at the same time?
2) I have earned income, as noted above, so do tax laws have any problem with me using this inheritance to contribute to a Roth? I know that when one makes over a certain amount of cash regularly over a year, said person is not eligible for a Roth IRA. However, this inheritance wouldn't count as "earned income", would it? (Of course I'll pay all the necessary taxes on the inheritance)

Thanks all, and in the interest of full disclosure I'm cross posting this over at the Clark Howard forums so I can get lots of different viewpoints and advice.

[meaghanchan]

Originally Posted by newgolddream

Hello all-

My biggest questions are:

1) Can I have both a 401k and a Roth at the same time?
2) I have earned income, as noted above, so do tax laws have any problem with me using this inheritance to contribute to a Roth? I know that when one makes over a certain amount of cash regularly over a year, said person is not eligible for a Roth IRA. However, this inheritance wouldn't count as "earned income", would it? (Of course I'll pay all the necessary taxes on the inheritance)

Your plans sound solid so far! Good job for wanting to invest the money and not just spending it on a car or a fancy vacation!

1) Yes, you can have a 401(k) and a Roth at the same time. The contribution limits are (IIRC) $15,500 annually for the 401(k) and $4000 for the Roth IRA. You can contribute to a Roth IRA for 2006 until April 15 2007, so since you have $30,000, you could fully fund your Roth IRA immediately for both 2006 and 2007.
2) There is no problem with using an inheritance to contribute to a Roth, but someone more knowledgeable than me may tell you if this money counts as 'income' (my guess is yes) and if that affects your ability to contribute to a Roth for either 2006 or 2007. My guess is that if it puts you over the income limit, you may not be able to contribute to a Roth the year you receive the inheritance, but could the following (or previous) year. So, if you received it in 2007, you would be able to contribute for 2006; if you received it in 2006 you'd be able to contribute for 2007. Note that to be ineligible to contribute the full amount to a Roth IRA for a given year, your AGI (ajusted gross income) would have to be, IIRC, about $95,000.

Good luck- your fund choices sound like good ones!

[disneysteve]

Without knowing how much money we're talking about, I've got a few comments.

Whether or not the Vanguard 2045 fund is appropriate depends in part on your other investments. What investments are you using for your 401k money? You need to look at your overall asset allocation, counting all of your funds as one big pool of money. You can't treat the 401k and the Roth and the rest of the inheritance as 3 seperate unrelated accounts.

This is more of a personal comment, but I'm disturbed by the fact that your father "allowed" you $30,000 of the inheritance. Is it his money or your money? Did you ask him to manage it for you, or did he take that duty on himself? If he is doing it at your request, that's fine. Just be sure that you are involved in all the investment decisions with that money, so that it fits into your overall asset allocation, as I mentioned above.

[newgolddream]

Originally Posted by disneysteve

Without knowing how much money we're talking about, I've got a few comments.

Whether or not the Vanguard 2045 fund is appropriate depends in part on your other investments. What investments are you using for your 401k money? You need to look at your overall asset allocation, counting all of your funds as one big pool of money. You can't treat the 401k and the Roth and the rest of the inheritance as 3 seperate unrelated accounts.

This is more of a personal comment, but I'm disturbed by the fact that your father "allowed" you $30,000 of the inheritance. Is it his money or your money? Did you ask him to manage it for you, or did he take that duty on himself? If he is doing it at your request, that's fine. Just be sure that you are involved in all the investment decisions with that money, so that it fits into your overall asset allocation, as I mentioned above.

Apologies, I should have made some things more clear, and I used poor word choice. I am incredibly close to my parents. If I asked to have the full amount (210K, sans 50K to payoff my house, leaving roughly 160K before any applicable taxes), I could have it. The decision was based on a series of long conversations we had about my financial future. My dad has much, much more experience in investing and financial management then I do. I have deferred to his knowledge in this area. "Allowed" was a poor use of terms on my part, apologies for any alarms that might have raised. And thank you for your concern in that regard, disneysteve.

I do understand that I need to think of all of the funds as one big retirement umbrella. The individual funds in the Target Retirement 2045 are index funds, my 401K is in Fidelity International funds and a Mid Cap Growth fund, with the match going into company stock.

EDIT: My dad never had an IRA, which is why I want my focus to be on enjoying the tax-free benefits of a Roth.

[disneysteve]

Originally Posted by newgolddream

The decision was based on a series of long conversations we had about my financial future. My dad has much, much more experience in investing and financial management then I do. I have deferred to his knowledge in this area.

I do understand that I need to think of all of the funds as one big retirement umbrella. The individual funds in the Target Retirement 2045 are index funds, my 401K is in Fidelity International funds and a Mid Cap Growth fund, with the match going into company stock.

That's good. I kind of figured that was the situation.

As for your allocation, I'm glad you recognize the need to look at the big picture. Right now, 18.2% of Vanguard 2045 is in International funds. So if your 401k is also being partly invested in International funds, just keep track of how much of your overall portfolio is International. 20% or so is probably plenty, but you need to decide that on your own.

[kv968]

All sound advice, just let me reiterate what has already been said, keep an eye on asset allocation, particularly the mid-cap growth sector. That could get out of control quickly if you're continually adding to it. And by all means, keep your company stock at no more than 15% or so of your total portfolio. I've seen (and been through) too many bad things with holding too much of company stock in a 401k.

[cbird01]

I think that every portfolio should have a portion of individual stocks also. I would take a look at setting aside a portion of your funds for good dividend paying stocks. So that you do not have to do as much research, the folks at Motley Fool have an Income Investor service that evaluates and tracks the best dividend paying stocks. Each month they make new recommendations and a best "risk adjusted" list for new money.

I like the dividend stocks since they create an income flow that can be reinvested. Dividends will continue to rise and by retirement time, you will have a great monthly cash flow and can sell as you want or just live off the dividends and pass the stock to you heirs. I purchased a group of 8 stocks in diversified sectors, with a return similar to the Vanguard fund (15%), but after figuring in the dividends, my return was 20%. The extra 5% is reinvested which spawns more dividends (now multiply that by how many years before you retire) You could either do this in your Roth or open a taxable account. I would just make sure to use a discount broker like Scottrade or similar to keep trading costs low. (they have no annual fees and 1000's of no-fee mutual funds too)

The compounding power of reinvesting dividends is massive over the long haul. If you are interested, there is a great book by Ben Stein and here is the Motley Fool site.

I am sure there are some other good dividend newsletters out there if someone else has recommendations.

[creditcardfree]

As a beginning investor, I would stick to mutual funds and branch out to individual stocks if you find it interesting enough to do the research. Dividends are reinvested in mutual funds too, although not all stocks pay dividends.

I would continue your 401k and consider increasing the amount you contribute, max out my roth for both 2006 and 2007, set up an emergency fund of at least half your income in your GMAC account,...from there it depends on what your goals are.

If you have a short term goal to get a new car or furniture then I would keep some of the money in the GMAC account, but allocated towards these goals.

If you have long term goals (other than retirement) of more than 5 years, such as a newer home, or lavish vacation than you may want to buy mutual funds in a regular mutual fund account. The money would then grow faster than in your GMAC account and it would be available for goals that are before retirement. The earnings on this type of account would be taxable every year and gains would need to be paid at the time you sell the shares.

Best of luck to you. Take things slow if necessary. This is a great gift you have received and it's important that it blesses you to the highest degree possible.

[Ima saver]

As a beginning investor, I also would suggest you stick to mutual funds. I really like Index funds. I like Vanguard Index 500 and have most of my IRA money there.

[cbird01]

I can understand where Ima saver and creditcardfree are coming from. I was a beginner when I started investing in individual stocks and I just think it is more fun and more profitable. You can see the impact of dividends in my post in
this thread

I think the biggest factor is whether you like to learn about individual companies. You do not need to labor for hours on end researching if you subscribe to a proven newsletter that regularly beats the market by a large margin. If it is going to keep you awake at night, then go with the mutual funds.

[newgolddream]

Originally Posted by creditcardfree

As a beginning investor, I would stick to mutual funds and branch out to individual stocks if you find it interesting enough to do the research. Dividends are reinvested in mutual funds too, although not all stocks pay dividends.

I would continue your 401k and consider increasing the amount you contribute, max out my roth for both 2006 and 2007, set up an emergency fund of at least half your income in your GMAC account,...from there it depends on what your goals are.

If you have a short term goal to get a new car or furniture then I would keep some of the money in the GMAC account, but allocated towards these goals.

If you have long term goals (other than retirement) of more than 5 years, such as a newer home, or lavish vacation than you may want to buy mutual funds in a regular mutual fund account. The money would then grow faster than in your GMAC account and it would be available for goals that are before retirement. The earnings on this type of account would be taxable every year and gains would need to be paid at the time you sell the shares.

Lots of good advice all around, thanks again!

For the time being I just want to stick to mutual funds and index funds to get my feet wet, though the idea of researching individual companies is interesting to me and could prove to be something I will enjoy.

I had not considered increasing the amount of money going into my 401k, I'll have to think about that. Problem is beyond 6% there is no match, so its just me putting more money in. This is money that could be going elsewhere, but then again what "elsewhere" offers the tax deferred benefits of a 401k. Something to chew on there.

Emergency account, check. I'll make sure to keep 6 months living expenses there.

At this time, I have no short term goals for a new car, furniture, etc. I have my hobbies (fountain pens, audio equipment, books) but I fund my hobbies on regular income leftover after necessities (food and bills). I also have no particularly long term financial goals, but then again who knows what may happen. Not a bad idea to have some money invested in some slightly more liquid areas (i.e. not a retirement account).

Thanks for the link to the Stein book, cbird, looks interesting, plus I've always been a Stein fan. I'll poke around on the Motley Fool as well, I've heard about that site many times but never spent much time on it except for a project once in high school.

Best of luck to you. Take things slow if necessary. This is a great gift you have received and it's important that it blesses you to the highest degree possible.

I've been incredibly blessed. I'll definitely heed your advice about taking things slow. Easy does it.

[newgolddream]

One more question I am having difficulty getting a second opinion on. Does the inheritance factor in on my modified adjusted gross income, therefore making me ineligible for an IRA in 2007? I do not believe this is the case. When I asked if an inheritance counted as MAGI over on the Clark Howard boards, I was told "Absolutely not, not under any circumstances," so that makes me feel more confident. I was just hoping to get some more reassurance.

[creditcardfree]

I would agree with your Clark Howard friends. Even if this $30K is added as income to your traditional income $23K for tax purposes, your MAGI is not above the thresholds stated earlier to disqualify you for a roth ira for 2007. So I feel competely confident that you are qualified to make that contribution.

My husband inherited a traditional ira from his father and we had to show that as taxable income I believe. However, we also received funds from the sale of his house, but any capital gains taxes on that were paid by the estate prior to us receiving the funds. I'd ask the executor or personal representative of the estate if they've filed taxes on the funds you have recieved to get clarification. Someone else may have a comment as well.

[newgolddream]

Originally Posted by creditcardfree

I would agree with your Clark Howard friends. Even if this $30K is added as income to your traditional income $23K for tax purposes, your MAGI is not above the thresholds stated earlier to disqualify you for a roth ira for 2007. So I feel competely confident that you are qualified to make that contribution.

My husband inherited a traditional ira from his father and we had to show that as taxable income I believe. However, we also received funds from the sale of his house, but any capital gains taxes on that were paid by the estate prior to us receiving the funds. I'd ask the executor or personal representative of the estate if they've filed taxes on the funds you have recieved to get clarification. Someone else may have a comment as well.

Actually the total inheritance is 210K, the 30K is just what I am currently handling. So, I guess I really need to find out how the government views that inheritance. I'll keep doing my research.

[kv968]

One thing that no one has mentioned yet (including me) is the tax consequences of your inheritance. Since you've just recently received this windfall, I would suggest that before you do any serious investing with it that you see a tax professional first and see what kind of taxes you owe on this money. They could also undoubtably answer your eligibilty question of a Roth.

[newgolddream]

Originally Posted by kv968

One thing that no one has mentioned yet (including me) is the tax consequences of your inheritance. Since you've just recently received this windfall, I would suggest that before you do any serious investing with it that you see a tax professional first and see what kind of taxes you owe on this money. They could also undoubtably answer your eligibilty question of a Roth.

Excellent idea, up until now I've just been guestimating at the amount of tax I'll have to pay; probably in my best interest to see a professional before starting a Roth.

[disneysteve]

Originally Posted by newgolddream

Excellent idea, up until now I've just been guestimating at the amount of tax I'll have to pay; probably in my best interest to see a professional before starting a Roth.

Absolutely. I wouldn't want to be estimating the tax on over 200K. That's a big chunk of money. An incorrect estimate could be off by thousands.

[kv968]

Originally Posted by newgolddream

Excellent idea, up until now I've just been guestimating at the amount of tax I'll have to pay; probably in my best interest to see a professional before starting a Roth.

Just out of curiosity if you don't mind, what is your guesstimation of what you owe?

[meaghanchan]

One thing I will restate: Since I assume you received all $200K in a single tax year (since it's all in your name, even if your parents are hanging on to some at the moment) even if it does affect your ability to contribute to a Roth in the year you received it, it won't in other years. So if you received the inheritance in 2006, you can contribute to a Roth for 2007. If you received it in 2007, you can contribute for 2006.

[newgolddream]

Originally Posted by meaghanchan

One thing I will restate: Since I assume you received all $200K in a single tax year (since it's all in your name, even if your parents are hanging on to some at the moment) even if it does affect your ability to contribute to a Roth in the year you received it, it won't in other years. So if you received the inheritance in 2006, you can contribute to a Roth for 2007. If you received it in 2007, you can contribute for 2006.

True. In the mean time I can do a little research about some mutual funds and index funds to begin DCA'ing into.

And kv968, my guestimation goes something like this:

210K total
-50K to pay off house
-50K taxes

=110K left to invest