Business Matters In investing lump sums, tax man’s shadow looms

By Pat Duffy

I have just received $175,000 in settlement of an injury claim. My wife and I are retired. Have you any suggestions as to what we might do with the money?

— G.J., Queens

First, readers should note that such an award will not be subject to taxes. Had you received any of it as punitive damages, that portion of the settlement would be taxable.

The easy answer to your question would be to tell you where you might invest it. However, it is your money. Therefore, it is your call. In order to help you make that call, let me run a few things by you that you should consider before making any moves.

From the way you’ve phrased your question, it sounds as though you don’t need the money immediately. So let’s make some assumptions and proceed.

We’ll assume you have sufficient income from interest ($8,500), pension and social security to meet your needs. In addition, you have an untouched lump sum and company stock from your old job.

Second, you have a mortgage. One consideration might be to pay down the mortgage, if, as is the case, you are well into the life of the mortgage. However, your tax return shows itemized deductions of more than $10,000 of which $4,500 are charitable contributions. If you pay down the mortgage, the numbers show that your itemized deductions will then be lower than your standard deduction. In other words, you will get no tax break from contributing so much to charity.

Third, you indicate that you want nothing to do with the stock market, especially as it is now so volatile. It is clear your comfort level with the stock market is very low. Also, you are already exposed to the market since you have a significant amount of company stock.

Fourth, at the present time, $8,998 of your social security benefits of $20,815 are being taxed. In order not to have any more of your social security taxed, you would need to have no additional interest income. This means that you would have to leave the money under the mattress. In this case, your dollar amount would be safe, but, because of inflation, what the money would buy every year would be less and less. In other words, you would be exposed to purchasing power risk. Not the best situation, since you are still comparatively young and could live for a long time yet.

So what to do with the money? Assuming a minimum interest of $8,000 can be obtained, a few scenarios might look like this:

At Investing in a Investing in a

Present Taxable Account Tax-Exempt Acct.

Taxable inc. $30,198 $44,998 $36,998

$4,526 $7,237 $5,546

All this means is that you would pay $4,526 in federal taxes if you never got the money. But you have received the money and so you would pay $7,237 in federal taxes if you invested the money and received approximately $8,000 in interest income. If, however, you invested the money in a tax-exempt investment, you would pay less, $5,546, in taxes.

You can see for yourself the difference in taxes when you invest in a taxable account and a tax-exempt account: approximately $1,700. Since you wish to pay as little taxes as possible and yet keep ahead of inflation, the answer is fairly obvious.

This solution answers all your concerns, (a) pay as little tax as possible, (b) keep ahead of inflation, (c) have your net worth grow, (c) stay away from volatile investments, and (d) be able to sleep at night.