High income, sudden windfall

Question

I currently earn quite a good salary (around $250,000 Australian dollars per year). Due to a recent investment coming good I am expecting to be receiving a windfall of around $1.2 million Australian dollars (after tax). My wife and I are both under 35 years of age, and we have two primary school aged children.

Because of my current high income, my wife does not work and has been a full time mother for the past 5 years.

We currently owe around $450,000 on an investment property in in a blue collar working suburb in Sydney that is currently valued at about $900,000 (and currently going down in value, although I expect the bottom of the market would be about $750,000 - so still ahead). The house is tenanted and the rental income is more than our mortgage repayment. Our current repayments have us on target to have it paid off in around 15 more years.

We carry no credit card debt or loans of any kind outside our mortgage (cars, gifts, holidays all paid in cash), but we do currently rent our primary home.

For our windfall I have allocated:

• $120,000 (10%) for charitable giving
• $120,000 (10%) "rainy day" fund
• If I'm being honest, more money than I should for a nice condition second hand Porsche 911

However that leaves around $900,000 unspent.

The reason we are renting our current home is because we live in a semi-rural area. Houses here take 6-12 months to sell and we didn't want to get stuck with a house we can't sell if we had to move back to a large city.

My current thinking is that I should not bother to pay down my investment property mortgage:

• It would take 50% of the remaining funds which could be used more wisely elsewhere
• We are earning more from the property than the monthly payment
• Interest payments are tax deductible
• If we have a bad year for maintenance and we dip into losing money on the house that year, that decreases our taxable income for the year (negative gearing)
• If we chose to buy our primary residence outright we would have much less money to do so
• It's not like we were cash strapped to begin with, so we could easily stay the course on this property and use the money to diversify our portfolio away from just property

However my wife strongly disagrees. She sees value in completely paying off the mortgage on our investment:

• The huge psychological boost for her knowing that the house is secure
• There is no year-to-year property taxes (just a single stamp duty tax when the property was purchased, and then capital gains tax when it's sold), so the ongoing ownership costs are extremely low
• Essentially, nobody can ever take that house away from us if we financially go down the toilet later in life
• Our children are entitled to very low cost higher education, so there's no need to put money aside for their college funds (and if we did so, an entire degree would be maybe $50,000)

Half my brain is yelling at me to just pay down our entire Sydney property and buy something cheap to live in with the remaining money.

The other half of my brain is telling me to leave the Sydney house alone, buy something cheap in our current town, not be too concerned if we have to take time to sell it later, and do something sensible with the rest of the money (invest, throw it into our superannuation accounts, etc)

The third half of my brain is telling me to spend all the remaining money on a really nice house in our current town and say "to hell with it" and just live here forever (it's a very nice area).

Answer 1

First congratulations and well done in both your salary and investment. Hopefully there will be more of this in the future.

First I applaud your initial approach. Give some, spend some, save some. The disagreement with your wife is standard. One member of a partnership tends to be more conservative than the other; the disagreements help bring balance into your life. Going too far in either direction is unhealthy and the balance keeps us healthy.

In your case, you are getting the Porsche and have 900K left over. Give your wife what she wants, a paid for house, and 450K is still available for investment. It gives you guys great downside protection. The income from the rental could then be invested as you see fit with a dollar cost averaging approach.

I'd encourage you to take some of that left over for investment and take a nice family vacation. Be a little extravagant. Also I would encourage you to make sure you have the proper amounts of insurance in place. Here in the US an umbrella liability policy would be in order, and I would recommend 2 million in coverage. You would also need a decent amount of life insurance on both you and your wife. Probably 1 million each in level term insurance.

Also I am really okay with you renting for now. You cite good reasons to rent, and if it helps you to continue to earn at your level then it is doubly good.

Keep up the good work!

Answer 2

What you do with your income, and with your windfall, should be based on your retirement goals, which you have not mentioned.

For many people, a paid-off residence and $1M in the bank would mean retirement could already start. But it seems your lifestyle (young children, Porche 911, etc.), won't quite allow for that. So you acknowledge that you will be working in the near term - but you haven't mentioned when that will stop. There are a lot of questions you should be jotting down now, and evaluating on an ongoing basis:

Will you pay for your children's university education [even 50k * 2 could push your retirement age out by a couple of years, depending on your lifestyle]? Will they live with you forever or will you throw them out like Jazzy Jeff on their 18th birthday? Do you want a 'summer home' you can visit in your golden years, or will you downsize to a 1 bedroom condo so you can shave a decade off your retirement age? You mention potentially 'having' to move back to the big city - does that imply you would prefer to live (now and in retirement) where you are?

The reason for the questions is related to risk. The longer you will be working until retirement, the longer you have for market ups and downs to correct themselves. Holding onto a mortgage (and using your available funds to invest, instead) may have a higher return, but it would also have a higher risk.

As well, there is risk in home ownership itself, aside from the risk of a mortgage. If you absolutely want to stay where you are, then buying a house can reduce the risk that increasing market prices make your neighborhood achievable in retirement. Likewise if you will likely be moving to a different real estate market, then renting can make it easier for you to move even during a market downturn. It sounds like you haven't quite decided where you want to live yet, so that will be the first clue to how firmly you want to tie yourself to your local real estate market.

If you're close enough to retirement that you can almost taste it, then reducing your risk by paying off your mortgage may be the right choice.

Your financial advisor should have already had you walk through your short term and long term financial goals, and if they haven't, now may be a good time to seek out a new one.

Answer 3

I'm going to be a bit practical here. Good for you for wanting to give to charity, but I'm going to ask you to hold off for a bit.

Warning, Will Robinson, Warning! As happens occasionally on this site, people are scammed into thinking they are getting a bunch of money and aren't actually going to get that money. Don't spend Any money until you get paid first. Also, don't give any money to the people saying they are going to give you this money. They may be trying to scam you. If it costs you a fee to get this money, consider it a scam. I know you said it was an investment working out, but my warning still stands, if for nothing else than to warn others in a similar, but not as confirmed position as you. If you know 100% that you are getting the money and it's not a scam, then the rest of my advice follows.

1. Debt
First things first, pay off as much debt as you can. It's good that you don't have many debts, so this'll give you more money to do the things you really want to do.
There are zero reasons to hold onto debt that you pay interest on if you don't have to. Just because it's a tax write-off doesn't mean it's doing you any good. That's just a fancy way of paying money to get a small return back. Let me say this a different way: would you give someone $10 so the government can give you $2 back? This is charitable giving, nothing else. All you're doing is making your creditor(s) more wealthy than they already are.

2. Retirement
Secondly, figure out your retirement needs. How much do you need to save for retirement and are you on track to meet that goal? Do you need to or can you put more towards retirement without negatively affecting you right now? Talking with a tax accountant/adviser can help you figure this out. The more you save now, the much more you'll have for retirement. Compound interest is your friend when it comes to retirement funds.

3. Emergency Fund
Third, out of the remaining money, decide how much you should add to your emergency cash fund. You will want to consider appliance replacement, vehicle repair/replacement, natural disasters, major health issues, and some other things with this. Don't go to an extreme, but don't assume you'll always just be fine or can "deal with it" when something happens. Getting a good insurance policy is key to making sure you don't have to save "everything".

4. Charity
Fourth, now you can feel free to give to charity. Once you have yourself financially secure, you can give some money away. This is the tax break you want. Talk to a tax accountant/adviser to see how much would benefit your taxes. That doesn't mean you have to give that much or you can't give more, you should just know how it'll affect your taxes before you do it. As an aside, you should also research who you are giving it to. Here in the States, a 501c3 and similarly setup charities will allow you to put the donation on your taxes, while other types of charities won't. Your tax person should be able help you figure this one out, too.

5. Enjoyment
Fifth, now you can play. I'd recommend against anything that's a "money pit", but that's entirely up to you. A motorcycle or a vehicle can cost you a lot of money in insurance, registration, repairs, upgrades, and more. It sounds like you are making plenty of money right now to cover all of that, but what if you lose your job or become disabled? Just consider that a vacation is a one time expense, rather than the recurring expense of a vehicle. The vehicle has recurring enjoyment, so it's a balancing act of what you really want.

6. Investing
Sixth, it sounds like you have a decent handle on investment properties and their expenses. I'll warn that these can be money pits and they are not all "created equally", but if you have a good enough understanding of how this all works, there's not really any reason you couldn't get another one and continue to reinvest in supplementing your income. This assumes that your current property is making you more money than it's costing you in repairs/maintenance contracts/salaries, taxes, etc, besides the mortgage.

Spend Wisely
It's great that you got this money, but if you don't use it wisely, it can turn into a curse. There's a lot of examples of people who win a lottery and end up bankrupt, since they either didn't have good financial sense to begin with, or their sense went out the window with the wind(fall). There's also plenty of examples of professional athletes who are paid millions a year, yet are broke, and for the same reasons. It's great that you are asking for suggestions here, and it sounds like you already know how to use your money to your advantage (no personal loans or credit card debt) so keep using your brain, instead of your adrenaline-rush, to make good decisions.

Answer 4

If your investment property is worth $900K now and you foresee it going down in value, why not sell it now and buy another one (or two) when the market bottoms out?

Your wife wants to reduce the risk in your life. If it were me, which of the 3 halves of your brain would I listen to? Not #3; saying "to hell with it" and just buying an expensive house where you are is dangerous. Right now you feel flush with cash and are tempted to spend too much because you have plenty.

I would encourage you to do nothing with the money for 6 months while the emotion runs out and you can make a calculated decision on where your family really wants to be 5, 10, 15 years from now.

Answer 5

1. Change the property.
   In the US there are ways to roll an investment property ownership to another more expensive property without paying capital gains on the first one (deferring until the sale of the next property/properties).

If that is an option in Australia, I would use between $1,000 and $50,000 to buy a new rental property in an area that you expect to go up in value (or at least hold its current value).
Seems less risky than waiting out a dip of $50k - $150 in value.

If that is not an option, consider $50k or so in renovations to keep it from going down in value as much as it otherwise would. I assume that would add to your cost basis for the property so you'd get it back out without taxes at the sale.

2. Pay it off

   My current thinking is that I should not bother to pay [off] my investment property

While I must trust you when you say that it couldn't be taken from you, there are still risks. Your renters could do a lot of damage to it, or something else could happen, like you get sued (and lose) regarding something that happens there.
This is a low risk for the reasons you gave.

More importantly:

• Your wife wants it.

• You have the money.

• Think of it as your wife's "second hand Porsche 911".

Plus, if you invest your former mortgage payment, you'd lose less than the value of your Porsche (in the long term).

3. Take your family on a nice vacation if you haven't already.

4. If you don't already have it, get disability insurance.
   As the only current breadwinner, the loss of your income for a year or so (without your death) could cause bankruptcy.

Answer 6

Firstly, congratulations - don't spend it all at once :)

Seriously though I'm with your wife. Always pay off your debts first. There's a good deal of satisfaction to be had from the feeling of not owing anyone any money. After that, despite your relatively young age, I'd be looking at investing the rest (except enough for a really good holiday, perhaps) for retirement. Put it somewhere that you can access the funds in an emergency (so not property), but think about building up a pot so that you have the potential to retire early should you wish to.

Ultimately as long as you can pay the rent and put food on the table, everything else is gravy.

Answer 7

Tax considerations are top of the stack

You seem content to collect the money, pay the tax, and then decide what to do with the money. That is offbeat enough I'd even use the word "wrong".

You need to talk to a tax lawyer or CPA who does not sell or recommend investments. (investments sold by advisors pay sales commissions, and they are inculcated to believe those products are the best investments. They're super not.) Then ask them about all the possible choices and their tax impacts.

A significant factor in your choices should be making the tax bill not so massive, to the extent your law allows.

This is YOUR money

Your worst enemy is your own brain thinking thoughts like "this is a winning"..... "I didn't earn this".... "this is lottery money" .... "this is mad money" ... "this is for spending". No it's not.

You earned this. You bet some money on a long shot investment and it came home. Or the money was directed to you by someone else, and they wanted you to use it to increase your wealth.

Wealth isn't your cash in the bank. It's your ability to create money and remain financially stable. Your investments do more to create wealth than your cash.

Unfortunately a large fraction of the population has a sensibility that money isn't for keeping. Whenever money comes into their hands, they must push it away. They spend it on frivolous things, they give it away to friends, charities, mooches etc., or they have a string of "emergencies" that gobble up their money. (They had the emergencies before this too, but they were able to find thrifty ways of solving them; possession of money blinds them to those solutions). Don't fall into this trap, and don't let your wife drag you into this trap.

Emergency fund

Since the 2008 crash, pundits have revised their recommended emergency fund upwards toward a full year. Given your resources, I think it would be crazy to keep back less than a 2 year emergency fund. That should either be in cash/stable liquid investments, or variable liquid investments like stocks but significantly more of them since you must assume their value will crash. For instance I consider $3 in stocks to count as $1 in emergency fund.

Your emergency fund is your genuine monthly burn rate x number of months. You may deduct expenses you plan to eliminate in hard times, such as weekly sports and music concert tickets, restaurant dinners, vacations, charitable giving, etc.

Renting is super OK

There's nothing wrong with owning rental property with one hand, and renting your primary residence with the other. That gives you flexibility, and also protects you from real-estate market challenges in the market you want to live in. Where I live, I wouldn't dream of owning - I love the location, but the market has big issues.

Again tax law is also a factor.

My rule of thumb is Don't own a house where the rental market isn't viable. That means you can always move, rent out the property and still be OK.

I hear your frustration about the housing market in that location. However, I am a big fan of Robert Irwin's "never sell" rule: keep those assets working forever, and let your next-of-kin pay the capital gains tax :) So if you do buy, select a property that's solid as a rental property, and keep it forever.

Real estate is a business. Leverage is good

I understand your wife's sensibility, but she seems to be debt-allergic. When you are a business, and you are... debt is actually leverage. Leverage is your friend. Leverage lets you own 4 rental properties instead of 1.

This is especially true when the mortgages are non-recourse, and their only option on a foreclosure is to take the house, they can't go after you personally for more.

A string of mortgaged rental properties and a rental property to live in is a fine combination.

There are better ways to invest, though

Depending on your market, there are stronger investments than real estate. In particular, the stock market in the long term usually beats the real estate market somewhat. However, it is not nearly as liquid.

Do consider the tax implications of stocks, particularly short-term vs long-term capital gain rates.

If you don't know what else to do with the money, investing it sensibly is a good plan. It is possible to achieve stupid-high growth in the long term by investing same as a university endowment is invested. The fundraising office will cheerfully tell you how they do that, since you are a potential donor, and the investments are simple - index mutual funds, REITs, that kind of thing (though you're already heavily into real estate so avoid REITs).

A note on charitable giving

Given the magnitude of your planned gifts, you really, really ought to use a Donor Advised Fund (DAF). This is a charitable "bank account" controlled by you. You place funds in the account today, and you enjoy any tax benefits today. The money doesn't just sit in the account, you can direct it to be invested. Mine is 100% in US stock mutual funds, for instance.

Then later, as you identify charities you want to support, you tell the DAF to make a donation out of your account. They automatically qualify the charity as bona-fide, liquidate the mutual funds, and send a donation check to the charity either on your behalf or anonymously. This does a bunch of things for you:

• separates the timing of doing the charitable donation from the timing of the charities receiving the money. Your gift this year benefits charities for many years in the future.

• You no longer donate in person. When a charity mooches from you, smile, get their charity ID #, and let the DAF figure out if they're legit.

• allows you to give anonymously, so you aren't flooded with junk mail and contacts.
• Money is invested and grows with the market.

Answer 8

Who else have you told? Strongly suggest you keep the win on the quiet and tell as few people as possible.

If you have already told a lot of people or if your win was publicised by the source, then anticipate a line of visitors to your door asking for a hand out.

They might be family, distant family, former coworkers, Ex-partners, schoolmates, or even people with the same first+last name trying to stake some kind of claim. And churches - if you've ever been associated with a church of any format then they may come canvassing for largess.

How you choose to deal with them should be decided before the event. It could be any combination of

• Sure here's $X,000 toward your hamster's homecoming prom frock.
• "the charity bucket contains $xx and that was donated to (Charity)"
• your and her parents get "a gift" and you siblings get some smaller gift
• "the win is paid out over 20 years on a schedule so I get 5% per year for 20 years"

Personally? Tell as few people as possible else there's a definite risk of it being whittled away.