Q. I will most likely be receiving a large inheritance ($100,000) sometime in the near future. I currently contribute the maximum to my 403b and also contribute to a Roth IRA. I am a homeowner with about $85,000 left on my mortgage, which has an interest rate of 6.75 percent. I am thinking of moving in a few years. My question: what to do with the inheritance? Should I pay off the mortgage and invest the rest? I assume probably not because of the low interest rate. As far as investing it, what would be my best tax-advantaged option? I currently have $26,000 in my 403b and $51,000 in my Roth. I am 32 years old.

---T.L., by e-mail

 

A. Whatever the bumps we experience in the immediate future, the long term--- that's 15 to 30 years--- prospect for common stock returns is about 11 percent annually, compounded. That's a lot better than the cost of your mortgage, with or without any tax benefits.

Your tax benefits, by the way, may not be as bountiful as you imagine. Assuming you are single, the standard deduction this year is $4,400. You get no tax reduction benefit from itemized deductions until they exceed this amount. Your mortgage interest this year, for instance, will be about $5,700 so only $1,300 will bring tax benefits plus whatever you have in other deductions, such as real estate taxes and charitable contributions. As I have pointed out in many columns, millions of homeowners get no real tax benefits from ownership. That doesn't mean they shouldn't own homes or shouldn't have a mortgage. It just means that money you borrow isn't as cheap as wishful thinking would have it.

My suggestion: put the entire inheritance in a money market account and commit it, over the next two years, to a low cost, tax efficient vehicle such as the iShares Russell 1000 Index Fund (ticker IWB). This exchange-traded fund duplicates the performance of the 1,000 largest capitalization domestic stocks, which account for about 90 percent of all market value in the U.S. market. Dividend income will be nominal and capital gain distributions will also be limited so it will be very tax efficient.

 

Q. Our annual income is $44,000 from a limited pension, Social Security, and an annuity. We plan on downsizing our home since, like many others, we are "house poor." My wife and I are 65 and have been retired for 5 years. The value of our property is about $250,000 and the house is on one acre. Annual taxes are $2,500 and the house is expensive and difficult to maintain. It is fully paid for and we have no other debts.

Our assets include: a $35,000 CD; a $135,000 variable annuity; a $15,000 IRA account; $30,000 in common stock; and $100,000 in whole life insurance. Our largest expenses have been medical bills, home maintenance, and property taxes. Our idea is to sell our present property and to purchase another home for about $150,000.

We then might purchase Treasury bonds with the $100,000 difference. Another option might be to obtain a property loan on the new house to enable us to deduct interest payments from our income taxes. This approach would also free up more dollars to purchase Treasury bonds.

Another idea is to locate a rental home if we determine that the tax advantages of house payments are insignificant. This option would provide the greatest opportunity to create a reserve fund.

Your thoughts?

---J.M., Salem, OR

 

A.  First, forget about a mortgage. It doesn't make sense to borrow at 7.5 percent to free up money to invest in long term Treasury bonds that yield 5.8 percent. Worse, there is a good chance you would receive no tax benefit since the standard deduction for a couple is $7,350 and the interest and real estate tax deductions on a $150,000 house would not exceed that by very much. Finally, depending on the exact sources of your income, committing to a mortgage may also commit you to having a taxable income large enough to bring on the taxation of your Social Security benefits.

You might increase your personal security more by using the cash value of your life insurance policy to buy a long-term care policy.