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Minimizing Taxes on Unexpected Income

Feb 28, 2005 | | Comments Comments Off

Q: I recently received compensation for serving as executor for a deceased neighbor’s estate. The amount was just under $10,000. I am 72, single, with few assets. What is the best way to invest this money so I don’t wind up paying a chunk in taxes?

In the retirement community where I live, this is a common question, because many residents serve as executors for their neighbors, and all have very modest income.

A: The income you receive as an executor or personal representative is taxable as income in the year you receive it, and there’s not much you can do about that. What you’re probably asking is how to minimize future taxes on any gains this money might generate.

One of the easiest choices, if you really don’t want to pay any taxes, is to simply invest in a tax-free money market account. These accounts typically invest in insured municipal bonds with little risk of loss, and your money is accessible whenever you need it.

What you probably don’t want to do is invest in an annuity. These are often pushed on seniors who want tax deferral, but annuities usually come with relatively high expenses and surrender charges that could seriously eat into your stash if you needed to withdraw money.

Before you do anything, though, you might want to have a chat with a tax professional about the implications of your investment. You may be overestimating how much this money will cost you. If you’re in the 15% tax bracket, for example, you may be better off in a taxable money market account that earns a higher return. Currently, taxable money market accounts are averaging better than 2%, while tax-free money markets average less than 1%.

Many seniors get in trouble with inappropriate investments in trying to avoid a tax bite that’s really little more than a nibble.

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