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Let us suppose that someone receives a lump sum settlement from a car accident (personal injury) case and would like to invest it for maximum long-term returns. We will say that the settlement amount is $100,000. We will assume that the receiver has a solid understanding of investing and initially plans to put the majority of the amount into mutual funds and commission-free ETFs. The latter will be used as part of a monthly auto-withdrawal for living expenses. Occasional trades for redistribution to maintain asset mix.

In determining the viability of this plan, what considerations need made regarding taxation in order to maximize long-term gain? To clarify the question, things that may come into play might be:

  • Tax savings via Roth IRA
  • Capital gains tax affects of redistribution trades
  • ETFs tax advantages over other investment options
  • Other unknowns

Essentially, like many, I am ignorant of much of the tax code around investment, other than the basics required for monthly retirement deposits, and do not want to make a mistake with this settlement. This question applies to the US tax code, specifically a resident of Pennsylvania.

Further Information

I'd like to expand upon the above question with further assumptions and restrictions:

  • Initial investment is $100,000, but a future larger settlement is possible and expected
  • No other income source can reasonably be expected in the future
  • Withdrawals will be expected to be less than appreciation
  • For the purposes of this question assume that this money will be invested in stocks, bonds, ETFs, mutual funds, or similar
  • This person has no other investment accounts
  • Net income is/was $23k annually
  • Investor is not married, but lives with a domestic partner and children and may one day marry
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    What is the person's age? When do they plan to retire? Are you saying they will use none of the money to live on in the short term? – Pete B. Jun 2 '14 at 13:12
  • Good questions. Assume the age is mid 30s. Assume that they will not be able to work in the foreseeable future and will pull out a monthly sum for living expenses. – Nicholas Jun 2 '14 at 13:28
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    @Nicholas - adding some remaining missing bits would help. Do they have any other savings? About how much is their income now? From what I read so far, taxes are the least of my concern. – JoeTaxpayer Jun 2 '14 at 13:54
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Well this is not the best situation. Sorry to your friend.

First off ROTHs are out, you need earned income. Secondly, I don't think the focus should be on retirement planning until there is again an earned income. Thirdly, this person is just in a bad spot.

Lets assume that you can find some really good mutual funds, that consistently return 10% per year. At best this person can only pull out 10K per year without touching principle. At that income level, taxes are not much of a concern; not as much as surviving. If this person knows anything about investing, they know funds don't work like this. They could be down 5%, down 5%, up ~40% in three years to give an average of 10% return. Which of course further complicates matters.

This person (IMO) should seek to start a different career. One that can cater to any long term issues this person has with pain/disability. The money could be used toward training/education in order to get money flowing again. That is not to say the full amount should be used for a BA in Russian Folk Literature, but some minimum training to get a career that starts earning real money.

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    I wonder how well your first sentence translates for our non English speakers. – JoeTaxpayer Jun 2 '14 at 16:36
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the $5500 Roth IRA is not restricted to earned income, you can put whatever money you have tax free and gains free.

  • Hey Kevmolio, I believe this statement is wrong. Can you provide a link to back it up? – Bishop Jun 13 '16 at 17:55

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