How to Tax-Shelter a Large Settlement

The Internal Revenue Service can require you to pay taxes on all income you receive, including the proceeds from a settlement. But you can get more use out of your money by investing in tax-sheltered assets. A tax shelter or haven is any method of reducing taxable income so that your effective tax rate is smaller. While the amount of taxes you pay will be determined by the settlement amount, there are some things you can do to reduce your taxable income.

Request a structured settlement. The most common form of structured settlement is created with an annuity, which is a stream of cash flows. Instead of receiving one lump sum, you can receive that amount over a long period of time, allowing you to better manage taxes.

Make a maximum contribution to your retirement fund. Your contributions are tax deductible up to a point. Both Roth and traditional individual retirement accounts offer tax advantages. But only traditional IRAs provide for tax-free contributions to the funds. Of course, you will be penalized if you withdraw your funds before your golden years. Between the age of 59½ and before age 70½, you can make penalty-free withdrawals. After that, a minimum distribution amount is required every year. You can deduct up to $5,000 a year for tax.

Invest in real estate. Not only is your mortgage interest and property tax deductible, but you can defer paying taxes on capital gains by using the 1031 Exchange offered by the IRS. This allows a single homeowner to excluded up to $250,000 in home-sale profit from taxation. This is double for married couples.

Invest in the stock or bond market. Long-term investments reduce your taxes primarily because they are taxed at a lower rate than regular capital gains, depending on your income (between 0 percent and 15 percent).