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Dr. Don Taylor, CFA, Bankrate.com advice columnistHow to invest an inheritance

Hi Dr. Don,
I am a 57-year-old woman who will never be able to afford to buy a house in the Bay Area. I recently received my only inheritance from Mom's trust and paid off all of my huge credit card debt.

I am planning to buy a Roth IRA, put emergency funds in three and six-month CDs earning close to 5 percent, and investing most of the rest in 5.75 percent to 6 percent CDs. I am finally able to contribute the maximum 15 percent to my 401(k), but wonder if that is wise when it reduces your Social Security income calculation.

My company only matches $1,500 in the 401(k) and I would be contributing over $9,000. I have enough to put in a Roth IRA in 2006 and 2007, but not in later years. Would I be better off lowering my 401(k) contribution in order to invest $5,000 each year in a Roth IRA?

I'm very confused ... this is the first time I haven't been in debt in years and the only time I've had any money to invest. Unfortunately, I only have $21,000 in a rollover IRA from a prior job for my retirement.
-- Jan Jumpstart

Dear Jan,
I'm always at a loss for words when I hear about someone getting an inheritance because I recognize that an inheritance often comes at a steep price, the loss of a loved one. Since that's your situation, I'm sorry for your loss.

Your salary deferral 401(k) contributions don't negatively affect your Social Security income calculations. That's because you're paying Social Security and Medicare taxes on the contributions. Here's what the IRS says on the topic in its publication, 401(k) Resource Guide -- Plan Sponsors -- 401(k) Plan Overview:

Although these amounts are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA).

If you've contributed up to the limit of the company's matching program, there's no need to max out the 401(k) contribution if you're eligible to contribute to a Roth IRA and you'd prefer to allocate your money to that type of tax-advantaged retirement account.

While I understand the decision to invest emergency funds in short-term CDs, allocating a large portion of your inherited wealth to CDs might be too conservative an approach in meeting your financial goals for retirement. At age 57 you shouldn't be swinging for the fences in your retirement portfolio, but a portfolio chock-full of CDs isn't right either.

Paying down your credit cards was undoubtedly the right thing for you to do. Now that it's done, what's going to stop you from running up those balances all over again? The inheritance is a gift that has given you the chance to wipe the slate clean and work toward your future financial goals instead of paying interest on yesterday's spending. Ask yourself what you are going to do differently to start living within your means.

I think you would benefit from meeting with a financial planner and discussing your finances, goals and investing. I recommend using a fee-based planner and getting a second opinion if you can't get comfortable with the recommendations. An earlier Dr. Don column, "Finding an independent financial planner," discusses the process of finding and hiring a financial planner.

To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: Oct. 27, 2006
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