Diverting an Inheritance Into a 403(b) Account

KELLY KEARSLEY for the wall st. journal writes: As a teacher in his late 30s, the man had many years of working and drawing a paycheck ahead of him. So when his aunt died and left him $50,000, he decided to set it all aside for retirement.

He and his wife liked the idea of stashing it over time in a tax-deferred account, such as a traditional IRA, but their combined income was too high to qualify for tax-deductible IRA contributions. Their financial adviser, John Scherer, came up with another idea: Transfer the inheritance to the client's 403(b) savings account.

A direct transfer was out of the question. As with all retirement plans funded through payroll deductions, the 403(b) didn't allow outside contributions. "We couldn't just write a check to his workplace retirement account," says Mr. Scherer, owner of Middleton, Wis.-based Trinity Financial Planning, which manages $18 million for 32 clients.

But there was an indirect way to accomplish the same thing. The teacher's salary was $50,000 a year, and he was directing about 10% of that to his 403(b), far less than the $17,500 annual limit in contributions,

Mr. Scherer suggested he defer an additional $1,000 a month in pay, depositing it in his 403(b), and replace it with a monthly withdrawal from the brokerage account where his inheritance was sitting.

While it would take four-plus years for a full "transfer" of the inheritance, any capital-gains taxes he might incur on returns from his brokerage-accounts investments would likely be more than offset by the savings in reduced income tax on his earnings. Given the couple's 25% tax bracket, they would save $3,000 a year on the $12,000 in deferred income.

While the tax savings were nice, the biggest benefit for the teacher and his wife was the significant boost to their nest egg. "This more than doubles his retirement savings for a few years--and because he was only 38, that really has an impact," Mr. Scherer says.

The plan wouldn't work for every client. Another couple might have wanted to keep the money where they could tap it before reaching retirement age without getting hit with an early-withdrawal penalty. But, in this case, retirement savings was this client's priority--and his adviser's.

"It's looking at the big picture," Mr. Scherer says.