We have a large sum of money coming as an inheritance from a relative who passed away while living and working abroad. Please advise how this will be handled once the electronic transfer of the funds is made to our account here in the United States.

Will this inheritance be subject to tax or do we just pay tax on the accumulated interest once it is here?

Can we avoid paying taxes on it by investing it in certain areas for retirement?

In the U.S. there is no tax on the inheritances. You may still need to file Form 3520. Read: Your U.S. Tax Return: Tax on Inheritances

Download this form:
http://www.irs.gov/pub/irs-pdf/f3520.pdf

If the bequest did not come from a foreign trust, corporation, or partnership fill in the informational part right at the beginning and then go right to part IV