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Columns: Dr. Don
Don Taylor, Ph.D., CFA, CFP   Expert: Don Taylor, Ph.D., CFA, CFP
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Lump-sum benefit escapes levy
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Beneficiary may not owe federal tax

Dear Dr. Don,
My father passed away in February 2008. I inherited $80,000 from two insurance policies. I need a way to protect this money from the (greedy) IRS. Can I put it into an IRA? What about some type of tax-deferred plan? Annuities aren't for me.

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Also I was thinking of using this money for a secured loan with my credit union. What do you think?
-- Lance Legacy

Dear Lance,
The beneficiary of a life insurance policy generally doesn't pay federal income taxes on the death benefit when it is paid as a lump sum. Your father's estate may have owed estate taxes on the value of the proceeds, but that burden fell on the estate, not you.

Inheritance or estate taxes levied by the state may apply. The Bankrate feature "Death and taxes: inheritance taxes" explains how these differ from federal estate taxation. You can click on Bankrate's "State tax roundup" to learn about estate and inheritance taxes as they apply to the life insurance benefits.

Keeping the IRS at bay really isn't the issue. Instead, the issue becomes how you invest the money. Taxes, while not unimportant, shouldn't be the tail wagging the dog in determining how to invest.

Several factors help determine your eligibility for contributing to a traditional IRA. They include whether your employer offers a qualified retirement plan and your filing status and income levels. See IRS Publication 590, "Individual retirement arrangements," or consult with a tax professional about your eligibility to contribute.

Depending on your tax bracket and your investment choices, you could do just fine investing in a taxable account that is managed for tax costs.

With $80,000 in hand, you haven't made a case for why you would need a loan. A secured loan with your credit union may be possible, but why do you need it?

An earlier column, "Getting a CD-secured loan," talks about this form of lending and how it can be advantageous in rebuilding a credit history -- if the lender reports the payment history to the credit bureaus. Otherwise, you're paying 2 percent to 3 percent more than you earn on the loan for money already available to you.

Bankrate.com's corrections policy -- Posted: Dec. 3, 2008
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