Wednesday, August 8, 2007

How to Use a Windfall?

I received my AARP: The Magazine today. In it was a column of the same title as this post.

The question put to columnist Eric Tyson was: "I'm 54 and just inherited $50,000, which is about what I owe on my mortgage -- the only debt I carry. Like many people, I have some retirement savings but should be saving more. What's the best use of this money?"

Eric replies by asking if he has 3-6 months savings in an emergency fund, and whether he has disability and long term care insurance. As to whether to pay the mortgage Vs investing, Eric took somewhat of a pass and said that it depended on his tolerance for risk.

My personal recommendation would be that the windfall first be used to increase his tax deferred retirement savings (I guessing that "some retirement savings" might be $50,000 or less). IRS limits for 401k contributions in his case are $20,500 this year, including the catch-up amount of $5000 for someone over age 50. And there will be a similar contribution amount next year. Would also recommend he take advantage of Roth IRA savings, if eligible. If not eligible, your income is pretty high, so same on you for such poor savings.

With a mortgage balance of $50K, I'd estimate that it's within about 10 years of being paid off. If not, then a contribution of $5-10K to the mortgage principal could put it within reach. While he may do a bit better in the stock market, he might not. A reduction in expenses when entering retirement is a more secure proposition.

But aside from what to do with the windfall, his retirement savings need to be structured to provide your retirement without depending on windfalls.

If I got a $50K windfall, I wouldn't have the same choices. I've already paid off my mortgage and am more than maximizing tax-advantaged savings. I'd probably put the money into an after-tax index fund at Vanguard.

What would you do with such a windfall?


SavingDiva said...

I would max out my 401(k) and Roth IRA options...I would set up a 6 month emeregency fund...then I would invest the rest...