Should I combine my retirement benefit and inheritance into an IRA?
Author : Jeff Fleming    -   Subject : Finance

Question:

I am 57 years old. After I "retire" this year from my current employer, I plan to become self-employed. I have set up an IRA account to roll over my lump sum retirement benefit from my current employer.

The wrinkle is that I am receiving a substantial inheritance from my mother's trust fund within the next calendar year. Can I put the inheritance into the IRA along with the roll-over money from my retirement fund? I invest in only low risk products -- I-bonds, short- and long-term CDs.

Answer:

One of the significant advantages of a traditional IRA is that contributions to the plan are tax deductible. Your dollars work double duty. Contributions reduce your income tax liability while simultaneously providing tax deferred growth towards retirement funds. Therefore, by referring to your soon-to-be received inheritance as a wrinkle, you've lead me to believe that you are concerned about the income tax liability of this substantial inheritance.

Boy, do I have some good news for you! Gifts and inheritances are received income tax free under the Internal Revenue Code. There are some exceptions such as when beneficiaries receive IRA proceeds or payments to beneficiaries from a tax deferred annuity, but I will assume this is not your situation since your inheritance is coming from a trust. If my assumptions are correct, there would be no need to contribute the inheritance into an IRA.

However, even if you wanted to for some other reason, you must keep in mind that tax deductible contributions to an IRA are limited to $2,000 (escalating to $3,000 in 2001, $4,000 in 2002, and $5,000 in 2003 under the recently passed Retirement Security and Savings Act of 2000).

So, an IRA would do little to shelter a sizable inheritance even if it were income taxable. You may analogize your inheritance to your lump sum retirement benefit, which you will rollover into an IRA, but that is a beast of a different color. You are merely moving pretax money from one type of retirement plan to another. Accordingly, the dollar limitation on contributions does not apply to rollovers.

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