How to allocate an inheritance?

[TBH]

Hello, all. It's been a while since I posted regularly but I still read the site quite often.

I'm expecting to receive an inheritance of around $40K to $50K later this summer and I'm having a hard time figuring out what to do with it.

I'm 35, my spouse is 49, and we have one child aged 8.

Our income varies quite a lot because I have health issues that sometimes keep me out of the workforce for a few months, and on top of that we both have regular jobs with paychecks AND freelance work. I would say we average $80K per year between the two of us, without much ability to increase that unless we made a major career change (unlikely.)

Our mortgage payments are $1100 per month but will probably go up to $1200 when the city revamps the tax structure this year. We have no debt besides our mortgage, which is good because I feel like we can barely afford our house. It's big and old and needs a lot of maintenance.

Here's a breakdown of our assets:

* Cash: $43K (emergency fund plus a couple of sinking funds for taxes etc)
* Retirement: $168K (in 403b accounts, Roths, a Rollover IRA and a SEP IRA) We save 15% plus employer match (5% me, 3% him) and I put 10% of my freelance income into a SEP IRA.
* Individual stocks $2800 (just play money, I know this is not a good investment, really)
* 529 accounts: $72K (mostly grandparent funded)
* House: value approx. $225K (down from $275K when we bought it in 2009), mortgage balance $180K at 4%, 30 year fixed and we just did a cash-in refi in April to bring our payments down.

Ideas for the inheritance:
* retirement! About half the retirement kitty is in my accounts, and half is in his. That means I'm on track at 35 and he's behind at 49. It might be wise to put some money into his retirement accounts.
* home improvements/maintenance. Nothing over-the-top, but we need a few things like an exterior paint job, a sump pump, and a few new light fixtures.
* Vacations! Don't worry, I'm not thinking of spending the whole thing on vacations. But it is very tempting to take our kid to Europe, staying with friends and family so we wouldn't need a rental car or a hotel.
* Buy a rental property. This is what I really want to do with the money. I've run some numbers and I think I could buy a nice 3BR rental that would pay for itself and maybe even have a small amount of positive cash flow right off the bat. However, I think this is a bad idea because we're not particularly handy (we can paint and rip up carpets and fix a toilet but nothing more than that) and because our lives are already pretty complicated as it is. But this has always been a dream of mine, and I would be looking at is as a retirement investment. The goal would be to have the rental property paid off by the time we retire so we could use it to boost our monthly income.
* College savings. This is not high on my priority list because we already have so much college savings compared with retirement savings. And you know what they say. You can borrow for college but not for retirement.
* mortgage paydown. I know this is not a great idea so I'm probably not going to do it, but reducing my mortgage is very appealing. I don't want to refi again so soon, but even putting a few thousand toward the principal on our existing loan would feel great. Right now we're on track to pay off the mortgage when I'm 65 and my spouse is 79. I reeeeaaallly don't want to wait that long to pay it off, and paying more now will save more interest over the long haul. But probably I should look to our retirement savings before I do this.

So, what do you think? I am open to any and all suggestions, except selling my house. Please don't tell me to sell my house.

Thanks in advance.
TBH

[josetann]

Let's see...first thing I'd do is see how that inheritance would affect your taxes. Don't want to spend all of the inheritance, to find out you owe a lot more in taxes (and that you were disqualified from contributing to your Roth IRA so now you have penalties, etc. etc.).

I'll make a wild assumption and figure you'll be left with $25,000. Given your current situation, I'd put $10k-$15k toward the mortgage (assuming you were planning on staying in the house long-term, sounds like it to me) and use the other $10k-$15k for that dream vacation. Again, this is just me, you might want to talk to a fee-based financial adviser instead.

[pokerpro43]

how to allocate an inheritance?

JoseTann,

You seem to indicate that an inheritance affects your taxes in someway? I was under the impression that you dont have to report one to the IRS when you do your taxes or pay taxes on one in any way. Is this correct?

[moneybags]

JoseTann,

You seem to indicate that an inheritance affects your taxes in someway? I was under the impression that you dont have to report one to the IRS when you do your taxes or pay taxes on one in any way. Is this correct?

Money inherited that has never been taxed will be taxable to the person who inherits it. For example, if you inherit money that is in a 401k, the money has never been taxed, therefore you would be responsible for the taxes on that amount.

[TBH]

Thanks for this. I was expecting people to tell me I should put it toward retirement, not the mortgage. But it's more fun to pay down the mortgage for some reason. I'd get more satisfaction out of that.

The money is from the sale of my grandfather's house. My father is one of the heirs. I'm not named as an heir, but my father wants to give some of his share to me and to my sibling. He's going to write checks to me and to my spouse, $13K each this year, in order to avoid the gift tax. Then he'll give us the rest of the money at the beginning of 2013. So I'm not expecting to have to pay taxes on it.

I was thinking of going to see a financial adviser for help with this. I have never seen one, and manage all our money myself. But our situation is so complicated that I'd like some help.

[JoeP]

If you're not sure, just sit on it for a while. Sooner or later, you'll have an "a-ha" moment and its purpose will be clear.

[LivingAlmostLarge]

Will your dad have enough to pay the taxes on it then gift it to you? So you aren't getting $50k this summer but $26k at most.

This means you can't really buy the second home you want? Unless you wait until 2013? I would honestly beef up the retirement and maybe use 10-20% for a vacation.

[snafu]

It's important to make a plan for each set of this money. You don't want it to dribble away with a few hundred here and a few hundred there. Since you'd like to go to Europe and won't need to pay for ground transportation or accommodations, I suggest you start looking at on-line sites to price flights [taxes & fees] in the shoulder and off season. I don't know which countries you plan to visit but once the Olympics have ended, prices will likely be more reasonable.

Paying a lump sum directly to your mortgage principal will save you a lot in interest because of the way mortgage amortization tables work. Ask your mortgage holder to run the figures based on say $ 2,000. lump sum for example.

Some of the money could be used to beef up DH's retirement a/c. It's time to review his retirement a/c holdings to see how they've done in the past 2 years. What percentage is in equity and what percentage is in income producing, what fees are you paying and what is the rate of return?

[TBH]

You don't want it to dribble away with a few hundred here and a few hundred there.

This is exactly what I'm worried about. It would be so easy. A vacation, a few house repairs, an extra week of summer camp for the kid, that dining room table we've wanted for years, and the next thing I know it will be gone. Even divvying it up between different savings options (mortgage paydown, retirement) would feel like this in a way.

It's true that we will be getting $26,000 this summer and the rest at the beginning of 2013. My dad wanted to write me one big check, and I said I thought tax consequences would be avoided if he split it up into two different calendar years. I'm not making any firm plans til I have all the money. My father is very generous but he's forgetful, and I wouldn't be at all surprised if the numbers look different when all is said and done. He's also semi-retired after getting downsized a couple years ago, and he's still figuring out his cash flow and deciding whether to stay in his house, etc. For that reason I'm uncomfortable taking the money, but he gets very mad at me when I say I don't think he should really be giving it away. He insists that he can afford to do it, and I don't really know the details of his financial situation well enough to say for sure. I do know his way of managing money makes me nervous (he believes in "leveraging" his money which is just a fancy way of saying mucho debt.) I feel like my only option is to take it, and quietly use it to shore up my financial situation in case he ever needs my help. That's part of why I'm tempted to buy a rental property. If my dad ever needed a place to live, he could move into my extra house and be closer to us. (Although he'd have to be in a pretty bad way before he'd either accept financial help from me or agree to move from his state to my state.)

Thanks, all of you, for your help. I am counting my chickens a little bit here, but I have been feeling anxious about the money so I wanted to get some advice.

Oh, and I talked to my spouse about it. We're going to tithe a portion of it. Not sure yet. Maybe 5%?

[TBH]

Just an update--

We got the first installment of the money and for now it's just sitting in a savings account while we decide what to do with it. I think we're going to do some necessary house maintenance right off the bat. I'm not sure what we'll do with the rest. I think I've managed to talk myself out of buying a rental property. I don't really need the added stress, and I'm nervous about doing something so risky when I don't really know what I'm doing. I think we'll end up doing a combination of house maintenance, tithing, beefing up our retirement accounts, paying down our mortgage, and maybe taking a modest vacation.