Dear Rick:
I’m in my early 50s, divorced with two adult children. My game plan is to work another 10 years and then retire. I will have a pension and that with Social Security and money in my 401(k) and IRA should be more than enough. I have just received an inheritance of about $150,000. My first question is, do I have any tax issues with this money? The money was from a life insurance policy where I was the beneficiary. My second question deals with what to do with the money. The two options that I’m looking at are either to pay off my mortgage which is at six percent, or to buy a fixed annuity. The rate I was quoted was 3½ percent and that was for 10 years. I am a conservative investor, and this year for the first time because of the new tax law, I did not itemize my deductions.

Thank you.
Paul

Dear Paul:
With regard to the life insurance, you have no tax issues. The money is an inheritance to you, and thus, the money is tax free.
In reviewing your options with what to do with the money, I would certainly recommend that you pay your house off. To me, it’s quite simple in that if you pay your house off, you’re getting a guaranteed six percent return after tax on that money. On the other hand, with the annuity, you are only getting a 3½ percent return, and that money is eventually subject to tax. Therefore, when you factor in the tax consequences, you basically are doubling your return by paying off the mortgage.

There’s another benefit to paying off your mortgage and that is the feeling of being debt free. There is something liberating about paying off your house. Therefore, for both these reasons, I recommend you pay off your mortgage.

The other end of the equation is that now that you won’t have a mortgage, what should you do with the extra money? If you can increase your contribution to your 401(k), or add to your Roth IRA, I would recommend you do so. On the other hand, since you said you have enough for your retirement, you may want to put this money away to use to scratch something off your bucket list. I’ve always believed it’s important to live for today and save for tomorrow. The fact that you would have no mortgage and saved for your retirement means you can afford to do something for yourself.

One last note for people who are thinking about purchasing a fixed annuity, I would be very cautious about locking the money up for a 10-year period. In today’s world, 10 years to me is an excessive length of time to tie up your money; particularly, in this low-interest rate environment. With most fixed annuities, your rate is not going to increase. If we go through a time period of rising interest rates, your return can be subpar. In this environment I would not want to lock money up for more than a few years, and that is why I generally don’t recommend fixed annuities. Most of the products sold today require you to lock your money up for at least seven years, and with some annuities you’re required to lock your money up for much longer periods of time. In fact, I recently talked to someone who was sold a fixed annuity who was required to lock the money up for 15 years. As far as I’m concerned, that is unconscionable.

We live in a world that is ever changing, and it’s important to have flexibility. If you lock money up for long periods of time, unfortunately, you’re going to lose that flexibility.

Good luck!

Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.
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