Managing a windfall, unique circumstances

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Topic Author
masters2010
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Joined: Tue Oct 29, 2024 3:20 pm

Managing a windfall, unique circumstances

Post by masters2010 »

I recently received a windfall of $1 million (net). I am in medical residency, so my income is ~$80k/yr, household income $140k. Income will be $450k in 2.5 years upon graduating. Our expenses are currently greater than our income, which was a conscious choice given the unique finances of physician training, wanting to buy a house valuing stability with two kids, and being able to have enough cash in HYSA to give ourselves plenty of runway. However given these circumstances, we haven’t been able to maximize retirement accounts, and would like to especially now.

My question is particularly with regards to this. Between work and IRA, spouse and I can put away $92k a year deducted from our paychecks (+ additional $7k into each Roth IRA). We also plan for the next two years to put the max contribution that is state income tax deductible($34k) into two 529s, totally $136k. How would you manage these retirement account contributions over the next two years? I was thinking to hold back $230k in HYSA, maximize monthly payroll deductions, and then just use this $230k for living expenses. I then have $230k slowly depleted sitting in a HYSA for 2 years, which may not be the best use, but figure is also a hedge against our upside down circumstances and ultimately worth it to maximize getting money into the retirement accounts. Is this how you would get the money into tax advantaged accounts over the next two years, or is there something else I might consider?

Otherwise we are adequately insured in all regards, have basic estate planning, adequate emergency fund (plus will beef up our runway). The other question is should we set aside additional cash for a possible move. We own a house, and intend to stay there through the end of residency training, but circumstances may change such that we want to move. We’d likely plan to rent at first given it’d be a new job / new city, but might be somewhere we know in which case we’d consider buying. I figure though even in this circumstance, will have some cash on hand, can always purchase contingent on sale of my home, or just elect for physician mortgage with 0% down.

In summary, in the next 2.5 years this would get $400k into tax advantaged accounts (401, 457, and ROTH for each of us, and $135k into 529s), I’d hold back additional $100k for runway/living expenses, and then put $500k into VTI/VXUS. Thoughts?


Emergency funds: Currently $110k in HYSA, functions as an emergency fund but primarily have this amount liquid as it serves to cover monthly expenses as our runway until completing residency.

Debt:
- Mortgage: $750k at 3.75% 30yr, currently at $715k
- Car: $15k at 5.5%
- No credit card or school loans

Tax Filing Status: Married Filing Jointly with Dependents

Age: 35

Total portfolio:: $990k with $1M windfall incoming

Current Investment Assets

Taxable $600k
VTI, VXUS, VGT

Tax Advantaged Accounts
$112k in spouse’s traditional 401k
$0 in spouses 457b
$132k in my Roth IRA
$0 in my 401k
$0 in my 457b
$7k in 529s
HomeStretch
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Re: Managing a windfall, unique circumstances

Post by HomeStretch »

masters2010 wrote: Tue Oct 29, 2024 11:01 pm … In summary, in the next 2.5 years this would get $400k into tax advantaged accounts (401, 457, and ROTH for each of us, and $135k into 529s), I’d hold back additional $100k for runway/living expenses, and then put $500k into VTI/VXUS. Thoughts? …
IMO your plan is a good one.

You may earn a higher yield by using a brokerage money market fund rather than a HYSA. You can link your brokerage and bank accounts to transfer $ to your bank monthly as needed.

Also pay off the 5.5% car loan.

Edits -
Open and fund Roth IRA for your spouse.

What will your marginal tax rate be for the next 2.5 years?
It looks like it may be low enough to consider making Roth (rather than traditional) contributions to retirement plans/accounts. This BH wiki page may be helpful:
https://www.bogleheads.org/wiki/Traditional_versus_Roth

Also consider tax-efficient fund placement across your portfolio:
https://www.bogleheads.org/wiki/Tax-eff ... _placement
Last edited by HomeStretch on Wed Oct 30, 2024 7:21 am, edited 3 times in total.
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HMSVictory
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Re: Managing a windfall, unique circumstances

Post by HMSVictory »

What would be wrong with zeroing out the house now - eliminating your largest monthly expense? The car needs to be paid off today.

I like the idea of being totally debt free and having a rock solid foundation (still leaves you with a $990k portfolio).

How did you accumulate a $990k portfolio before you even started working? Nicely done.

If you start your career as a doc with zero debt making $450k a year you are going to be able to build a substantial portfolio quickly.
Stay the course!
Topic Author
masters2010
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Re: Managing a windfall, unique circumstances

Post by masters2010 »

Good call with the MMF, I was actually planning to do that with VUSXX over the HYSA actually. Federal tax bracket will be 22% and then state 4.4%. I was planning to continue with ROTH contributions for now, and then after training predominantly traditional with also backdoor ROTH for both of us. Though this is a subject I need to read more about, particular as it pertains to RMD.

And to answer the last question, I previously had a business that I sold, in conjunction with a hefty gain on our last house, and most importantly robust family support with my education and in many other ways to set me up for success.
Outer Marker
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Re: Managing a windfall, unique circumstances

Post by Outer Marker »

HMSVictory wrote: Wed Oct 30, 2024 7:11 am What would be wrong with zeroing out the house now - eliminating your largest monthly expense? The car needs to be paid off today.

I like the idea of being totally debt free and having a rock solid foundation (still leaves you with a $990k portfolio).
+1. With that much spare cash, I'd be very tempted to pay it off. Sure, you can probably make more in the market, but that is not guaranteed. We're pushing really lofty PE ratios in the market, and Vanguard's 10 year outlook on US equities is in the range of 3-5% -- with a lot more risk. I don't think having a paid off house is something you'll ever regret. And if we have a 30-40% correction in the market that we're overdue for, you'll have substantial regret. Below 3% on the mortgage I would not pay it off, but you're a bit higher. I would also not over-fund the 529 accounts.
lakpr
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Re: Managing a windfall, unique circumstances

Post by lakpr »

I would take a 3.75% guaranteed return over 30 years any day. The comparable long term bonds are EE bonds, and they are yielding only 2.7% right now. In other words, I agree with @OuterMarker above, to pay off the mortgage and eliminate the biggest expense in your budget.

Car loan interest is not tax deductible, so on the car loan you are also paying a 5.5% after-tax interest. Even at 22% marginal tax rate, that is equivalent to 7% guaranteed if you pay it off. If a bank were to offer you a 7% CD for 3 years (or however long the remainder term on the car note is), but with the caveat that this rate is applicable only for a maximum of $15k, would you be tempted? I know I would be making a beeline to such a bank!
Topic Author
masters2010
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Re: Managing a windfall, unique circumstances

Post by masters2010 »

Interesting thought about paying off the house, I hadn’t really considered that. How about if we are likely to move in 5-10 years? I guess you’re still getting 3.75% for that time and can decide whatever want to do after that.
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HMSVictory
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Re: Managing a windfall, unique circumstances

Post by HMSVictory »

masters2010 wrote: Wed Oct 30, 2024 10:16 am Interesting thought about paying off the house, I hadn’t really considered that. How about if we are likely to move in 5-10 years? I guess you’re still getting 3.75% for that time and can decide whatever want to do after that.
When you sell the house they will cut you a check (or send a wire). The money isn't lost - its just earning a GUARANTEED 3.75% return.

The bonus is you are going to sleep MUCH better with zero payments to anyone in the world - trust me on this one doc.

The final point is when you are completely debt free with a very low overhead you can be a much more aggressive investor (knowing you have a substantial portion of your wealth in a safe place - where you live). :D
Stay the course!
myartman
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Re: Managing a windfall, unique circumstances

Post by myartman »

I would only add to have a contingency plan if either or both of you lose your abilities to work. If that's a 1% likelihood, do you account for that in your plans?
HomeStretch
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Re: Managing a windfall, unique circumstances

Post by HomeStretch »

Personally, I would prioritize the retirement contributions + car loan payoff + maybe the 529 contributions (depending on the age of your kids, these can be made later when earning $450k/year). This doesn’t leave you enough from the windfall to fully pay off the mortgage but you can do a substantial payment against principal. In 2-1/2 years when you are earning $450k/yr, you could likely pay off the remaining mortgage balance quickly.
lakpr
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Re: Managing a windfall, unique circumstances

Post by lakpr »

masters2010 wrote: Wed Oct 30, 2024 10:16 am Interesting thought about paying off the house, I hadn’t really considered that. How about if we are likely to move in 5-10 years? I guess you’re still getting 3.75% for that time and can decide whatever want to do after that.
If you are likely to move within 5 to 10 years, a comparable investment would be an intermediate term bond with a duration of approximately 7.5 years.

According to this link from Vanguard, brokered CDs up to 7 years are yielding 3.95%
https://investor.vanguard.com/investment-products/cds

So on the face of it you are losing about 0.2% per year. But remember, the mortgage interest is only partially deductible, only to the extent that it + SALT vaults you over the standard deduction amount. So $750k * 3.75% = $28,125 and SALT = $10,000 max, with the result of itemized deductions being $38,125. But the standard deduction is $29,200; so you are really getting a tax benefit on only $38,125 - $29,200. Call it $9,000 for round numbers.

In your 22% tax bracket, that's a benefit of $1,980.

So the effective after-tax interest you are paying on the mortgage is $28,125 - $1,980 = $26,145. Or 3.486% AFTER-TAX.

Meanwhile that 3.95% you earn on brokered CD is fully taxable, so your after-tax interest is 3.95% * (1 - 22%) = 3.081%.

Paying off the mortgage is still superior.
terran
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Re: Managing a windfall, unique circumstances

Post by terran »

Sounds like a good idea. I've also used taxable savings to supplement income while contributing more to retirement than I could really afford. One thing to consider is that while the usual advice is to not invest money you need in the short term your situation is different because you're not spending the money, you're just moving it from one account to another. Think of it this way: if the market goes down during this period you aren't just selling low and spending that money, you're also buying low in your retirement accounts, so the net effect isn't that you've sold more shares of your investment, but rather that you've moved more shares from taxable to tax advantaged. Given that I'd invest it all in your desired asset allocation. I'd also put as much in Roth as you can since your income is expected to go up so much.
snowday2022
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Re: Managing a windfall, unique circumstances

Post by snowday2022 »

HomeStretch wrote: Wed Oct 30, 2024 11:48 am Personally, I would prioritize the retirement contributions + car loan payoff + maybe the 529 contributions (depending on the age of your kids, these can be made later when earning $450k/year). This doesn’t leave you enough from the windfall to fully pay off the mortgage but you can do a substantial payment against principal. In 2-1/2 years when you are earning $450k/yr, you could likely pay off the remaining mortgage balance quickly.
Agree mostly but I would superfund the 529s. Don’t pay off the mortgage, you may move after training. Retain liquidity.
Scoop21
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Re: Managing a windfall, unique circumstances

Post by Scoop21 »

lakpr wrote: Wed Oct 30, 2024 12:22 pm If you are likely to move within 5 to 10 years, a comparable investment would be an intermediate term bond with a duration of approximately 7.5 years.

According to this link from Vanguard, brokered CDs up to 7 years are yielding 3.95%
https://investor.vanguard.com/investment-products/cds

So on the face of it you are losing about 0.2% per year. But remember, the mortgage interest is only partially deductible, only to the extent that it + SALT vaults you over the standard deduction amount. So $750k * 3.75% = $28,125 and SALT = $10,000 max, with the result of itemized deductions being $38,125. But the standard deduction is $29,200; so you are really getting a tax benefit on only $38,125 - $29,200. Call it $9,000 for round numbers.

In your 22% tax bracket, that's a benefit of $1,980.

So the effective after-tax interest you are paying on the mortgage is $28,125 - $1,980 = $26,145. Or 3.486% AFTER-TAX.

Meanwhile that 3.95% you earn on brokered CD is fully taxable, so your after-tax interest is 3.95% * (1 - 22%) = 3.081%.

Paying off the mortgage is still superior.
OP can also compare to money market rates since the mortgage can be paid off at any time. FZDXX is currently yielding 4.7% or 3.67% with your after tax math. They can take the free money in the near term, and if rates drop pay off then. Or if rates rise they start earning more.
lakpr
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Re: Managing a windfall, unique circumstances

Post by lakpr »

Scoop21 wrote: Wed Oct 30, 2024 1:09 pm OP can also compare to money market rates since the mortgage can be paid off at any time. FZDXX is currently yielding 4.7% or 3.67% with your after tax math. They can take the free money in the near term, and if rates drop pay off then. Or if rates rise they start earning more.
no issues with that plan... the only "flaw" is that you are comparing ultra short-term rates against intermediate or long-term rates ...
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grabiner
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Re: Managing a windfall, unique circumstances

Post by grabiner »

One potential reason you might not want to pay off the mortgage: if you donate part of that windfall to charity, you may itemize deductions even without the mortgage, and thus all of the mortgage interest would be deductible.

If that is the case, you can earn more on a bond investment in a taxable account than on paying down deductible mortgage interest. And you can change your mind later; if bond yields fall to less than your after-tax mortgage rate, you can sell the bonds for a gain and pay off the mortgage then.
Wiki David Grabiner
mortfree
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Re: Managing a windfall, unique circumstances

Post by mortfree »

As I read your post you made it seem like you were broke / just making ends meet as expenses are higher than income.

Then you throw out that you have 900k with another million coming in.

The only other thing I see in this thread is that you will have to resist lifestyle creep when your income balloons to 450k.
Closer to 50 than 40
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