$100,000 - What to do?

[Bonedry]

I have just inherited $100,000 tax-free from a relative who passed away. What should I do with it?


Personal Financial Situation:

I am 33 years old, and make $65,000/year at a 'high' security job. I do not forsee any major pay-raises (except periodic ones for inflation), and I plan to work until I am in my 60s.

I max my 401k every year (currently $16,500 yearly) and the balance in my 401k account is currently $100,000.

I receive a tax-free gift of $5000 every year.

I receive $3500 every year in my tax-return.

I bought a house 5 years ago for $199,000 @ 6.5% (30-year fixed, $40,000 down - no PMI) and currently have a principal balance of $139,000.

I have a second mortgage (home equity line of credit) debt of $19,500 @ 5.75%.

I own 2 vehicles that are paid off and have low mileage.

I have no credit card debt.

I have a ZERO balance in my savings account, and my checking account balance is nearly dry at the end of each month.

I have a ZERO balance in my traditional Ameritrade (Stock/Bond) account.

I have a ZERO balance in my Ameritrade (ROTH/IRA) account.


I am a firm believer that saving as much as possible NOW is the key to a lavish, if not comfortable retirement, and I want to get the house paid off ASAP so that I won't be throwing my money away paying interest for 25 more years. This last year, I have been putting extra money into the principle of the house each month (about $400 each month). After the house is free and clear, I plan to invest the bulk of my future paychecks in the Stock Market/Bond Market.

That being said... what should I do? Pay the house down, pay off the second mortgage, invest the full amount, other ideas?

[KTP]

Lucky you (but sorry for your loss unless it was some unknown rich uncle)

The only thing I will likely inheret is a history of heart problems and diabetes

But I digress. Back to your "problem"

-$20K into emergency fund (split between checking, savings account, and some laddered CDs)

-$10K into Roth IRA (5K now, 5K in Jan)

-$20K home equity line payoff

refi the house down to at least 5% and don't pay it off early. Keep paying the extra $400 a month though if you must.

Of the remaining 50K, set aside 20K to fund your Roth for the next 5 years, so perhaps a medium term municipal bond fund for that. The last 30K, invest 20K in a Vanguard stock market fund you like (small cap would be great) and the very last 10K goes to coke and hookers (kidding).

[jpg7n16]

Originally Posted by Bonedry

That being said... what should I do? Pay the house down, pay off the second mortgage, invest the full amount, other ideas?

Step #1: either buy some budgeting software, buy excel, or buy a pen and paper to create a budget.

-You make too much money to have nothing in savings, and if you're able to save the max in your 401k, you should be able to consistently spend less than you make.

Step #2: determine your average expenses for a month.

-You should always have a proper emergency fund (EF) in place. I'll assume you're married (you have 2 cars) - so you should likely keep around 5-6 times your monthly expenses in cash. But no more than 6 months in cash.

Step #3: fund your EF from the $100k
Step #4: fund your Roth (and spouse's?) $5k each, from the $100k
Step #5: keep another $5k (10k?) out to fund next year's Roth IRA
Step #6: take a portion of what remains as some personal spending money, or charitable giving (or both); that amount is up to you, but hopefully not more than 25% of whatever remains after completing steps #1-5
Step #7: I'd probably pay down whatever remains onto your mortgage.


At some point, you'll need to decide what financial goals you have for yourself and your family. My recommendations are based on the goals of #1 - saving for retirement early and often; and #2 - get out of debt

[Snodog]

Originally Posted by jpg7n16

You make too much money to have nothing in savings, and if you're able to save the max in your 401k, you should be able to consistently spend less than you make.

In fairness he is spending less than he makes with a very nice 25% savings rate. His problem is he doesn't have any money that he can easily access without penalty should Murphy come a knockin.

Bonedry- Sorry to hear about your loss. Here is what I would do if I was in your situation. I am also assuming you are single since you didn't mention anyone else.

Put 25k in an emergency fund.

Pay off the second mortgage.

Put 5k in a Roth IRA for this year and 5k for next year. You may be able to max out a Roth every year now that you have no second mortgage. If you can't I would make up the differece with the extra money that you were paying on your first mortgage.

Throw the remaining 45k or so at the first mortgage.

[MonkeyMama]

I agree with the emergency fund advice.

I don't think you have a budget problem at all. Just a "too much to retirement/mortgage - no cash for a rainy day" problem.

So set some cash aside for an emergency. Maybe $20k - $40k. 6 months to a years' worth of take-home pay, would be a good starting point.

I also agree with the advice to refinance. You can pay a chunk down on the mortgage, lower your interest rate, and thus lower your mortgage payments. 4% - 4.5% is not hard to find these days for a 30-year mortgage. Maybe even 3.75% for 15 years (which you'd probably prefer?).

If you can lower your mortgageexpenses with a refi, put the difference into savings or ROTHs on a monthly basis. Or, plow extra into the mortgage. If I were you, I'd put the difference to ROTHs. (Cash reserves would be taken care of, and ROTH would be advantageous over low-interest rate mortgage loan. For the long run...).

[KTP]

Almost every response we make on SA has funding a Roth pretty high up in priority (usually right after getting EF established and making sure you get 401K match). And yet it is amazing how many people post their current budget and savings with no mention of Roth.

Being unable myself to directly contribute to a Roth because of income limits (but can do expensive taxable conversions now), I cannot stress what a great deal you are missing if you skip a Roth and instead just invest in a taxable account. If I could go back in time I would kick myself in the butt a few times to make sure I funded a Roth when I was eligible. (After also mentioning to my earlier self to buy Apple stock).

[littleroc02us]

I'm assuming that the 2nd mortgage line of credit is exactly what I think it is. More debt. It's just called something different. Pay it off first. You state that your a saver, but I wouldn't do any saving until all your debt is gone except the mortgage. Then make sure your EF is fully funded 6-9 months. Whatever is left max out the Roth's, because there is no better deal than that. I just put $1500 in mine today. The past 18 months have been incredible in my index fund.

[Slug]

1)Head on over to sunkcostsareirrelevant.com
2)Click in the Paypal Donation area.
3)Deposit $50,000.
4)Rest assured I will sleep better under my new roof and relax better in my solar-heated pool.

In lieu of the above approach, be sure to re-finance your mortgage and build out the emergency fund and fund the Roth.

[Hector]

We see a lot of responses about funding roth. Shouldn't tax bracket matter? Shouldn't it be different for someone in 15% brackets compare to the one who falls in 30%?

[disneysteve]

Originally Posted by Hector

We see a lot of responses about funding roth. Shouldn't tax bracket matter? Shouldn't it be different for someone in 15% brackets compare to the one who falls in 30%?

Yes and no. It depends somewhat on your world view and your personal slant on taxes.

I would rather pay taxes today and not have to pay them in retirement.

I believe the historically low tax rates that we currently enjoy won't/can't last and that taxes are likely to be substantially higher in the future. Thus, I think paying taxes now is a better deal.

Another thing to consider is that only about half of all US workers have access to a 401k plan. I don't. So for those folks, a Roth is the only tax-advantaged retirement account available.

[Snodog]

Originally Posted by Hector

We see a lot of responses about funding roth. Shouldn't tax bracket matter? Shouldn't it be different for someone in 15% brackets compare to the one who falls in 30%?

Good point. I think it is good to be tax diversified and since he currently has no $ in Roths he should build up his Roth then re-evaluate in 5-10 years and possibly switching to a traditional IRA. Its really a guessing game with lots of variables. But no you may not want to overdo the Roth especially if you are going to have low income in retirement. IMO

An additional advantage of the Roth that I like is being able to take the contributions out at any time. This is valuable for people like the wife and I who want to retire early and may need to fund a few years with Roth's

[ddavis]

If it were me...

1. Tithing $10,000
2. Emergency fund $20,000
3. Pay off 2nd mortgate $19,500
4. $5000 to take my family to Disneyland - I love Disneyland
5. Put the rest toward the 1st mortgage.

[jpg7n16]

Originally Posted by Hector

We see a lot of responses about funding roth. Shouldn't tax bracket matter? Shouldn't it be different for someone in 15% brackets compare to the one who falls in 30%?

Originally Posted by Bonedry

I am 33 years old, and make $65,000/year ...

I max my 401k every year (currently $16,500 yearly)

65000-16500 = 48500

Which given that you would reduce this amount even further using personal exemptions and standard deductions - it is impossible for the OP to be above the 25% tax bracket. Single or married.

2010 Tax Brackets Announced

IMO the Roth makes the most sense (esp as I think OP is married - putting them in the 15% bracket for sure)

[Hector]

Originally Posted by jpg7n16

65000-16500 = 48500

Which given that you would reduce this amount even further using personal exemptions and standard deductions - it is impossible for the OP to be above the 25% tax bracket. Single or married.

2010 Tax Brackets Announced

IMO the Roth makes the most sense (esp as I think OP is married - putting them in the 15% bracket for sure)

Seems like we are excluding stat income tax!
I am in CA and stat income tax is not very low here.

[snshijuptr]

BTW, in case Bonedry is thinking that he/she doesn't need an EF because the job is "safe", remember that an EF is for ALL life's little emergencies: water heater, car accident, medical emergency, death in the family, etc. The EF in my mind is the "don't carry a credit card balance while I wait for insurance money" fund. 3/6/9/12 months depends on how much risk you have in your life (job risk, medical risk, insurance premiums risk, # dependents risk, # assets risk, etc).

[Bonedry]

For the record...

I am single and have no dependents. In my mind, my number one priority is to pay the mortage off immediately since I would be able to save/invest most of my wages thereafter (although you are all slowly changing my mind on this perspective).

One option I have considered is to throw the entire amount into the mortgage (@ 6.5%, leaving a $39,000 balance) and then put the bulk of my wages into the principal for the next 2 or 3 years until it is gone (I would still be maxing the 401k during this period). After that, I would go after the second mortgage (@ 5.75%) and then start saving (EF, ROTH, ect) from scratch.

I realize that I will live frugally and have no personal 'safety net' in case of emergencies, but my parents are well-off enough to help me if I should run into any real emergenciies.

Thoughts?

[MonkeyMama]

Beyond everything else mentioned about the ROTHs, there is probably no other tax shelter for his income - he's already maxed out the 401k. So, regardless of his income, if he wants to build up a large amount of savings, the ROTH is a decent tax shelter. (Beats no tax shelter, in my opinion. Many wealthy people fund non-deductible IRAs along the same vein).

[MonkeyMama]

Originally Posted by Bonedry

.

Thoughts?

Lack of liquid cash can lead you to financial ruin. I would not skip an EF. If you are not a fan of a large EF, at least put away $10k. I have personally found that $5k covers most of life's emergencies, but would always save more because unlimited factors could affect a job. Do you have disability insurance? Your job could be steady, but what if you are disabled tomorrow? Stuff like that. In addition to the fact that anything can happen to anyone's job.

The thing is, if you refi the mortgage (15 year/substantially lower rate), and apply maybe $80k - $90k of the money to the mortgage, it will still be paid off considerably faster than your current trajectory.

Maybe real numbers will help you:

Your mortgage payment is about $1k per month, and the principal is about $200/month. You are adding $400, so paying $1400/month total and reducing the principal by $600/month total.

If you used the cash to save $20k, pay off $20k LOC, and reduce your mortgage by $60k, and refied to a 15-year loan, you would have payments of about $750/month. You would then continue to pay $1400 per month total. You would be paying down principal at a rate of $1050 per month. This puts you on a trajectory to pay off your mortgage in about 6 years, with the same payments that you are already paying. You just shaved about 10 years off your mortgage, and have some cash savings for a rainy day. That is precisely what I would do in your shoes.

I would love to have my mortgage paid off to, but am not going to sacrifice my short-term financial health to do so.

P.S. Our parents are also in great financial health but I would never put myself in a position to rely on them. I think of them in the worst case scenario. IT feels warm and fuzzy to know that you have that to fall back on in the worse of times, but that's about the extent of my thoughts on that. Do your parents a favor and let them stay in great financial health.

[snshijuptr]

If you are mature enough to own a house, then you are mature enough to not rely on your parents in an emergency. If your water heater burst tomorrow, you'd want some money sitting around while you wait for your insurance check. Don't expect to borrow from your parents. Be an adult and have cash set aside to pay this off.

Put aside 3 months expenses (only minimum expenses, not discretionary expenses). The idea is the cost of repairs is proportional to your expenses. If you have higher expenses, you probably have more dependents, more debt assets, more expensive cars, etc. 3 months expenses is probably only $10K for you.

Alternatively, you can do a few simple calculations. How much would it cost you if one of your cars was totaled? What is the cost of the most expensive repair in your home (assume you have to move out during repairs)? What would happen if you were hospitalized for a week (include lost pay)? What are your insurance deductibles? Now think about the worse case scenario that you find reasonable. That will give you the money to save.

Then you can use the rest of the money to pay down your mortgage.

[Bonedry]

I have decided, thanks to you all, to put 10k cash aside for an EF, pay off the second mortgage, fund my ROTH account, and put the balance into the mortgage principal. I am going to also refinance the home next year (a 10 or 12 year fixed) with whatever rate I can get. This will allow me to do both the responsible thing and also the... responsible thing.

In terms of ROTH for 2011 - I thought that the max used to be $4000/year... Is it still this way? Also, do I still have until April to fund the previous year?

I think I will be emotionally better off knowing that I have an EF set up, not to mention I will still be able to pay the house off in about 5 years.