Investing a cash inheritance

[Opus 17]

Consider the situation where a person who is still in their working years inherits cash, lets's say $100,000.  

A. It could be invested in mutual funds.  When withdrawn in retirement, the principal is not taxed and the gains are taxed as LTCG at 15%.  (And there may be some dividends taxed at 22% along the way.)

B. The person could increase their pre-tax 401k contributions from (let's say) $10,000 per year to the max of $31,000 per year.  This results in a $15,000 reduction in take-home pay, which is made up from the cash inheritance.  So the 401k can be maxed out for about 6-1/2 years.   This results in an immediate tax savings from the wage income of at least $5000.  But it converts the inheritance, which was tax-free, into an instrument that could be taxed at 22%.

C. The person uses strategy B but places the money in a Roth account in the 401K. The person gets no immediate tax savings, which means the strategy only works for 5 years instead of 6-1/2. But the gains after retirement are now tax-free instead of being taxed at 15% or 22%.

Looks like Roth is the way to go.  Or am I missing something?

(Person already has a Roth IRA that is maxed out, and already has a Roth 401k, so the 5 year clocks are already satisfied.)

[Deepp]

Hello Opus 17, 

Your conclusion that strategy C - Roth 401K is likely the best choice is correct. 

You cannot take the inherited 100K and contribute into your 401K custodian. However, you may be able to indirectly contribute by substantially increase your payroll deduction.

Alternative, B can work if you knew for certainty tax brackets would be much lower in your retirement age than now. 

Hope this helps. 

[M-MTax]

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@Opus 17 wrote:

Looks like Roth is the way to go.  Or am I missing something?

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Yes; age, risk tolerance, personal, including financial, situation.

EX: Young (young-ish) married couple with 2 kids. Combined income of $100,000. If they're living in an apartment paying rent, they might be infinitely better off using the $100k as a down payment on a house. 

[Opus 17]

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@M-MTax wrote:

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@Opus 17 wrote:

Looks like Roth is the way to go.  Or am I missing something?

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Yes; age, risk tolerance, personal, including financial, situation.

In this case, we can assume the person is comfortable on their own income, and wants the lowest tax strategy that preserves the money for their own retirement.  Risk tolerance can be dealt with once the money is in the correct instrument. 

[M-MTax]

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@Opus 17 wrote:
In this case, we can assume the person is comfortable on their own income, and wants the lowest tax strategy that preserves the money for their own retirement.  

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They may also have other needs (or wants), such as improving their current living situation. This is, after all, a hypothetical where $100k is inherited and not in savings through earnings (i.e., more of a windfall).