Managing A Modest Windfall - Request Feedback and Recommendations

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kmanjir
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Managing A Modest Windfall - Request Feedback and Recommendations

Post by kmanjir »

I have had a recent windfall and I am trying to decide through several options and was hoping to get some guidance from you. I have already read through the 'Managing a Windfall' Wiki page. For the purposes of this discussion, I am rounding the amount to ~$300K for easy math in the options I am thinking through below. I had sought the advice of this forum a couple of years back when my finance management/allocation was in a mess, and I am still thankful for all the guidance I had received then. Happy to report that I have continued with that guidance till date with no significant deviations from the plan I had chalked out since then. I have since been on autopilot.

Here's additional background and context from my side:
Emergency funds: Yes, 12 months of expenses
Debt: Yes, remaining mortgage of $250K refinanced to 1.875% last year (15 years)
Tax Filing Status: MFJ (with one child)
Tax Rate: 24% Federal (effective tax rate lower)
State of Residence: WA
Age: 40
Desired Asset allocation: 70% stocks / 20% bonds / 10% cash+CDs

New Contributions for 2022 (including his and her contributions)
  • Roth IRA --- $12K --- (Completed for 2022)
  • 401k (pre-tax) --- $20.5K --- (Completed for 2022)
  • 401k Roth (after-tax) --- [$61K -$20.5K - Employer Match] --- (In progress)
  • HSA --- $7.3K --- (Completed for 2022)
  • Taxable --- $25K --- (In progress)
  • I-Bonds --- $40K --- [Completed for 2022, 2023 (Gifts purchased for each other)]
  • 529 Contributions --- $24K --- (In progress)

Trying to think through a few options and reasons why (outlined below) on how best to inject this windfall into my ongoing plan.

A. Payoff remaining mortgage ($250K) + Taxable ($50K)
  • No more monthly mortgage payments; mental peace of no debt + redirect future funds to taxable (that would have been mortgage payments)
  • Note: I recognize that the 1.875% mortgage rate is about as low as it can get, and there shouldn't be harm in holding and paying it to term, but
    nothing for mental peace than getting rid of that debt and associated interest payments

B. Contribute to kid's 529 plan ($75K) + Taxable ($225K)
  • No 529 contributions for next 5 years, and if/when I resume after 5 years the monthly contribution will be ramped down from current $2K/month
  • Continue paying down mortgage according to regular plan - no change from current state as far as mortgage goes


C. Payoff remaining mortgage ($250K) + 1-time contribution to kid's 529 plan ($50K)
  • No more monthly mortgage payments; mental peace of no debt + redirect future funds to taxable (that would have been mortgage payments)
  • No 529 contributions for next 2 years

D. Contribute everything to taxable according to IPS ($300K)
  • Not currently my first choice, even though it is likely the simplest course of action. This is primarily because I feel this is a once-in-a-lifetime opportunity for me to get rid off the mortgage OR make a hefty upfront 529 contribution in one fell swoop and then not have to think about it for a long time.

Right now, I am leaning towards Options A and C mostly. The chance to pay off the mortgage in one go is very tempting.
I have not considered any options where I do a partial pay-down of the mortgage.

Question: Any additional pros/cons to the above approaches I am not considering? Any other options I should be considering in my situation?

Thanks!
CaptainT
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by CaptainT »

What grade is kid going into this fall? The older the kid the more I would be upping the 529

Fyi baring more information I lean Option D. Invest Taxable according to your asset allocation. That mortgage is super low rate and probably not worth paying off early. You are funding the 529 and even if not full college amount then you can always sell investments for college. (Or to pay off mortgage if so.ehow that becomes a need )
Last edited by CaptainT on Mon Aug 08, 2022 4:58 pm, edited 1 time in total.
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rocket354
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by rocket354 »

I think it's hard to give confident advice without seeing a more complete financial picture, for example what are the current balances of your various accounts?

I will say that you seem predisposed to getting rid of a mortgage that's at an eye-popping low rate. Is there a reason you haven't already paid it off, say from your taxable account? What has changed?
RetiredAL
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by RetiredAL »

CaptainT wrote: Mon Aug 08, 2022 4:51 pm What grade is kid going into this fall? The older the kid the more I would be upping the 529

Fyi baring more information I lean Option D. Invest Taxable according to your asset allocation. That mortgage is super low rate and probably not worth paying off early. You are funding the 529 and even if not full college amount then you can always sell investments for college. (Or to pay off mortgage if so.ehow that becomes a need )
+1

D gives you far more flexibility down the road. Using those $ to pay down mortgage locks up those $, largely out-of-reach.
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by Carefreeap »

CaptainT wrote: Mon Aug 08, 2022 4:51 pm What grade is kid going into this fall? The older the kid the more I would be upping the 529

Fyi baring more information I lean Option D. Invest Taxable according to your asset allocation. That mortgage is super low rate and probably not worth paying off early. You are funding the 529 and even if not full college amount then you can always sell investments for college. (Or to pay off mortgage if so.ehow that becomes a need )
+1

Your'e in your 40s and flexibilty is key. I would feel diferently if you were in your 60s and wanted to retire...errr maybe not. I have interest rate envy.
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8foot7
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by 8foot7 »

Paying off a 1.875% mortgage is quite frankly a bad idea. Peace of mind is worth different things to different people, sure, but you will never see that rate again. It’s gone, vanished, unable to be gotten again if you change your mind.
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by harikaried »

Where is the $300k now? If your taxable brokerage account is at Vanguard, you could park it in Vanguard Federal Money Market Fund VMFXX currently yielding 2.2% to have more time to decide and maybe have $300,500 in a month while you decide. If your account is at Fidelity, you could get the same yield with Fidelity Money Market Fund Premium Class FZDXX which requires a minimum initial $100k investment that you can then lower later and buy additional no longer needing to meet the threshold.
mortfree
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by mortfree »

I wouldn’t put anything towards the mortgage.

I wouldn’t put anything in the 529.

Do you have a car fund?

Do you have a vacation fund?

This could be a time to establish a separate bucket for those items.

Does your house require any upgrades? Flooring, roof, HVAC, etc. might be worth using the money towards that.

With that low of a mortgage rate chances are if you need to borrow money for anything like the above that the rate will be greater than the mortgage rate.

If all above are not needed then I would keep 50k “cash” and invest the other 250k and forget about it.
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squirrel1963
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by squirrel1963 »

OP, congrats for the windfall and also being really good finding all investment / saving opportunities, most people outside of BH don't buy I-bonds and certainly don't front-load bonds using gifting, I've been buying I-bonds for me and DW for 7 years, and only found out this year on BH. So you should really feel good.

As to your question, honestly you cannot go wrong either way, there are trade-off always. I assume your only debt is mortgage?

A) Paying off mortgage:
** PRO: peace of mind, most people especially here hate debt.
** CON: currently it makes no financial sense, if 1.875% is fixed rate you will not get a deal like for a very long time, and chances are you may never get it. Lowest fixed rate I got on jumbo that I ever got was 2.25% last year, if there is such thing as "good" debt, it's 1.875%. It's below average US inflation and certainly below current inflation of 9%. You are literally making money right now out of your debt.

B) 529 plan contributions:
** PRO: it's the best thing you can do for your children right now financially speaking FOR THEM. Education is priceless.
** PRO: this is also not just a financial decision, many parents (including my wife and I) prioritize their children education, as parent I feel it's my most important job even if it is against my own interest.
** CON: it's probably not the best thing for your finances, usually the progression of your savings should be, fill up emergency funds and liquid cash, looks like you done that), second payoff debt except mortgage see applicable CON for that, third max out tax deferred contributions (done that), fourth investing and/or 529 plans. Not sure it's actually the right progression, but as long as you have enough EF and your jobs is stable, investing is best thing to do.

C) Investing
** PRO: most likely best financial decision IF you don't need the money in the next 10 years or so.
** PRO: market timing is universally a bad idea, but stocks look very cheap now, or at least cheaper than last year. so long as you just invest now and hold on even if there a recession, it's difficult to go wrong. So long as you understand MARKET TIMING DOES NOT WORK, buying stocks now looks very attractive. In the long term it does not really matter when you buy.
** CON: see above

So what to do?

I would not pay off mortgage. I would not make any prepayment other than the stated monthly payments. Your mortgage right now is making money, your debt this year is actually 9% cheaper after accounting for inflation. Even with no inflation you can still make money by buying 300K of treasuries at near zero risk, today 6-months to 3 year treasuries give you more than 3% interest. 1 year is the best at 3.3%.

Please note that when I refer to treasuries I am referring to individual bonds/notes/bills. A treasury fund or ETF is subject to interest rate risk and you will lose money if interest rates go UP. Also once you buy you shold hold them to maturity otherwise you might lose principal.

So right now I would actually go for option D:

D) buy time -- put 150K or 300K in a 6-month treasury at 3.15% or 1-year treasury at 3.3%, or you can also do 3 months at 2.6%. you can also do 3 months now and extend by another 3 month treasury in November. Obviously you can choose other maturities as you please, you can even get a 1-month treasury and keep rolling over the money every month until you decide.

E) if you decide option D with 150K, you can invest immediately 150K according your asset allocation and keep doing D with the remaining 150K.

F) you could decide to buy inflation insurance with 150K but it's not for the faint of heart. So you can buy an individual TIP and when it matures you will get the promised real yield (i.e., the promised interest rate) plus inflation. The reason this is not for the faint of heart is that currently TIPS which mature next year have negative yield.

In other words if you buy a maturing on April 2023 you will get for instance a -0.5% interest rate. If annualized inflation is 9% from now to April you will roughly get 8.5% nominal interest rate by April. With normal treasuries (called nominal treasuries to distinguish them from real treasuries like TIPS) you will get about roughly 3% nominal interest rate. You can very clearly see that a TIP gives a much better deal IF, AND ONLY IF, inflation stays above 3.5% until April and current real yield for April TIP is -0.5%.
You can also get an earlier TIP in January but the real yield is not good. Most people really panic at the idea of buying a bond with negative interest payments, but the operational keyword here it's a real yield and must take into account inflation adjustments. You can also get July maturity but I feel that April is long enough for you.

As I said this is absolutely not for the faint of heart and it's risky. Holding normal treasuries is also risky of course, but because it's nominal money you do not see the negative interest rate of a nominal treasury.


So as I said, option (F) is somewhat risky. It would be my preference but I said it has to work for you and only you.

So, all in all, I recommend option (D), followed by option (E), or if you want also invest a bit in your kids 529 plan.

Do let us know what you decide and ask any question you want. Please do not pick option (F) because I mentioned it. I mentioned it because you buy I-bonds, so presumably you understand the benefits and risks of inflation protection. Otherwise if you have any doubts do not do it.

EDIT: please forgive me for the many spelling errors and poor grammar, I typed on the iPhone - bad habit!
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grabiner
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by grabiner »

I often recommend paying off mortgages, but a 1.875% mortgage with 14 years left isn't worth paying off. You can earn 3.48% pre-tax on Admiral shares of Vanguard Intermediate-Term Bond Index, which has about the same duration as the mortgage; this is 2.64% after tax. Or you can earn 2.62% on Admiral shares of Vanguard Intermediate-Term Tax-Exempt, which has a shorter duration.

Thus, you might invest a "mortgage payoff fund" in a bond fund, and make the mortgage payments from that fund; you retain the option of paying off your mortgage from that fund at any time if you need to. If rates fall, you won't have wasted anything because the falling rates will cause the price of the bond fund to rise when you do the payoff. If rates rise, you continue to hold a bond fund which now pays much more than the mortgage rate.
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InNameOnly
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by InNameOnly »

I will be the odd man out and suggest plan C.
While your interest rate is low, it’s still debt that you owe.
If you should lose you health and/or your income, you and your family’s financial stability is greater with a home you own.
The realist sees the glass as completely full, 50% water and 50% air.
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grabiner
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by grabiner »

InNameOnly wrote: Tue Aug 09, 2022 9:44 am I will be the odd man out and suggest plan C.
While your interest rate is low, it’s still debt that you owe.
If you should lose you health and/or your income, you and your family’s financial stability is greater with a home you own.
And that's why I suggest a mortgage payoff fund. Having a $250K mortgage and a $250K bond portfolio leaves you with the same ability to handle the mortgage as having neither one, as you can pay off the mortgage at any time if you want to, or withdraw from the bond portfolio to make the mortgage payments. And at current yields, the bond portfolio will pay more interest than the mortgage costs.
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kmanjir
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by kmanjir »

Thanks for all the responses. I did expect to hear a 'no' on trying to pay off such a low-rate mortgage, but didn't expect it to be so resounding!
Point taken - this is a heart vs head situation for me, for sure.

I also did some calculations on the mortgage and interest savings and basically I'd be saving about $37K in interest if I were to pay it off now (so ~$2500 / year spread over 15 years)

Answering some of the specific questions asked:
What grade is kid going into this fall? The older the kid the more I would be upping the 529

Fyi baring more information I lean Option D. Invest Taxable according to your asset allocation. That mortgage is super low rate and probably not worth paying off early. You are funding the 529 and even if not full college amount then you can always sell investments for college. (Or to pay off mortgage if so.ehow that becomes a need )
Kid is just 2 years old right now. The thought behind putting in $75K as a lump sum now was to give it as much time in the market as possible now and take a break from contributing for the next 5 years. Of course this might backfire if the market does really badly over the next several years and I miss opportunities to buy low.

Where is the $300k now? If your taxable brokerage account is at Vanguard, you could park it in Vanguard Federal Money Market Fund VMFXX currently yielding 2.2% to have more time to decide and maybe have $300,500 in a month while you decide. If your account is at Fidelity, you could get the same yield with Fidelity Money Market Fund Premium Class FZDXX which requires a minimum initial $100k investment that you can then lower later and buy additional no longer needing to meet the threshold.
Good point - it was in a Savings account for a month or so, but it's now at Vanguard already sitting in VMFXX. :)

I wouldn’t put anything in the 529.

Do you have a car fund?

Do you have a vacation fund?

This could be a time to establish a separate bucket for those items.

Does your house require any upgrades? Flooring, roof, HVAC, etc. might be worth using the money towards that.

With that low of a mortgage rate chances are if you need to borrow money for anything like the above that the rate will be greater than the mortgage rate.

If all above are not needed then I would keep 50k “cash” and invest the other 250k and forget about it.
I don't have a car fund as such but I do have one for home repairs/maintenance.
The vacation fund has piled up over the last few years what with a new baby and clamping down on travel during Covid, so we're good on that front.
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kmanjir
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by kmanjir »

squirrel1963 wrote: Mon Aug 08, 2022 8:40 pm
F) you could decide to buy inflation insurance with 150K but it's not for the faint of heart. So you can buy an individual TIP and when it matures you will get the promised real yield (i.e., the promised interest rate) plus inflation. The reason this is not for the faint of heart is that currently TIPS which mature next year have negative yield.

In other words if you buy a maturing on April 2023 you will get for instance a -0.5% interest rate. If annualized inflation is 9% from now to April you will roughly get 8.5% nominal interest rate by April. With normal treasuries (called nominal treasuries to distinguish them from real treasuries like TIPS) you will get about roughly 3% nominal interest rate. You can very clearly see that a TIP gives a much better deal IF, AND ONLY IF, inflation stays above 3.5% until April and current real yield for April TIP is -0.5%.
You can also get an earlier TIP in January but the real yield is not good. Most people really panic at the idea of buying a bond with negative interest payments, but the operational keyword here it's a real yield and must take into account inflation adjustments. You can also get July maturity but I feel that April is long enough for you.

As I said this is absolutely not for the faint of heart and it's risky. Holding normal treasuries is also risky of course, but because it's nominal money you do not see the negative interest rate of a nominal treasury.


So as I said, option (F) is somewhat risky. It would be my preference but I said it has to work for you and only you.

So, all in all, I recommend option (D), followed by option (E), or if you want also invest a bit in your kids 529 plan.

Do let us know what you decide and ask any question you want. Please do not pick option (F) because I mentioned it. I mentioned it because you buy I-bonds, so presumably you understand the benefits and risks of inflation protection. Otherwise if you have any doubts do not do it.

EDIT: please forgive me for the many spelling errors and poor grammar, I typed on the iPhone - bad habit!
Thanks for bringing up this option I had not thought about at all, squirrel1963. I will need to do some digging into this to understand the full implications of the 'nominal treasuries' - I don't feel like I have grasped it.


grabiner wrote: Tue Aug 09, 2022 10:36 am
InNameOnly wrote: Tue Aug 09, 2022 9:44 am I will be the odd man out and suggest plan C.
While your interest rate is low, it’s still debt that you owe.
If you should lose you health and/or your income, you and your family’s financial stability is greater with a home you own.
And that's why I suggest a mortgage payoff fund. Having a $250K mortgage and a $250K bond portfolio leaves you with the same ability to handle the mortgage as having neither one, as you can pay off the mortgage at any time if you want to, or withdraw from the bond portfolio to make the mortgage payments. And at current yields, the bond portfolio will pay more interest than the mortgage costs.

Grabiner - good point about the Vanguard Intermediate-Term Bond index option, that would have never occurred to me.

I need to spend some more time thinking on the options, but if I steer away from the mortgage payoff option, I think I will put some in the 529 and invest the rest in taxable per my IPS.
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squirrel1963
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by squirrel1963 »

kmanjir wrote: Tue Aug 09, 2022 11:11 am Thanks for bringing up this option I had not thought about at all, squirrel1963. I will need to do some digging into this to understand the full implications of the 'nominal treasuries' - I don't feel like I have grasped it.
.......
.......
I need to spend some more time thinking on the options, but if I steer away from the mortgage payoff option, I think I will put some in the 529 and invest the rest in taxable per my IPS.
Normally we use the wording "nominal Treasuries" when talking about TIPS/I-bonds because they offer a return in real dollars (real dollars = inflation adjusted dollars), so to avoid confusion we slap the label "nominal" to identify it.
There is nothing else to it, it's a label used to avoid confusion.

Since you indicated right that you'll spend more time thinking about what to do, the best thing IMHO would be buying a 3-month treasury to give yourself 3 months to think about what to do. Today a 3-month treasury is 2.67%, so it's worth buying if it's higher than whatever yield you get right now from a money market.

BTW my answer about mortgage payoff is not a resounding no, it's "no" only when considering the financial side of it. The peace of mind of not having any debt is a great feeling to have (i know how it is because I'm now retired and the mortgage is paid off), but given your situation (still in accumulation phase) I would opt for not paying off the mortgage, putting some money in 529 plan and investing the rest is IMHO the best choice for you.

Honestly there is no wrong decision here, they are all good options, ultimately you need to choose what works best for you and your family.
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by snowday2022 »

B. Front load the 529, rest in taxable. If you and your spouse has 529s for your child, you can put 32K per year in without incurring gift taxes. Do that for next few years to max state tax deduction. Or do 32x5 and you’re done with education funding likely (if you put in stocks).
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by Robdac »

D. This from someone who paid off the mortgage early. That's a once in a lifetime interest rate. And with current inflation you'll be paying back pennies on the inflated dollar.
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by squirrel1963 »

Robdac wrote: Tue Aug 09, 2022 7:52 pm D. This from someone who paid off the mortgage early. That's a once in a lifetime interest rate. And with current inflation you'll be paying back pennies on the inflated dollar.
YUP. With 9% year inflation, a 2% mortgage becomes 7% cheaper every year.
In other words OP real interest rate is currently -7%.
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Re: Managing A Modest Windfall - Request Feedback and Recommendations

Post by grabiner »

squirrel1963 wrote: Tue Aug 09, 2022 8:09 pm
Robdac wrote: Tue Aug 09, 2022 7:52 pm D. This from someone who paid off the mortgage early. That's a once in a lifetime interest rate. And with current inflation you'll be paying back pennies on the inflated dollar.
YUP. With 9% year inflation, a 2% mortgage becomes 7% cheaper every year.
In other words OP real interest rate is currently -7%.
This isn't the right comparison, because past performance is not an indication of future results. 9% was last year's inflation rate, but the after-inflation benefit of paying off a 14-year mortgage depends on inflation over the next 14 years, which is not likely to be 9%. (For example, a 10-year Treasury currently yields 2.80%, and a 10-year TIPS currently yields 0.33%, which suggests that bond traders expect 2.5% inflation over the next 10 years.)

But I do recommend keeping this mortgage, for reasons unrelated to inflation. Paying off the mortgage gives a return equal to the mortgage rate, and the OP can get a better return at very low risk with a bond portfolio. The bond portfolio plus the mortgage will come out ahead of paying off the mortgage, regardless of what happens to inflation.
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