Inherited $250K.. what's the "smart" move? I need your help!

[joerh]

Long time lurker, first time posting, admitted novice. I'm in need of your advice... as in, what would you do in my situation.

I'm a 33 y/o male, engaged to be married in April of 2013 to a 31 y/o female. I'm about to receive an inheritance of around $250,000. Please take into account our current situation of being single, and near future marriage (and hopefully 1-2 kids starting 2-5 years from now).

My investment goals:
Stocks: 80%
50%US, 50% foreign
Small cap and value tilt on US stocks
Bonds: 15%
Reits: 5%

Retire at age 65 with 70K/yr (as a very realistic goal, I'm shooting for 50 y/o though), 4% withdrawal rate from savings, own my home free and clear, own 5 rental properties free and clear that average $4,000/mo in rent, giving about $2,000 in cash flow per month, or $24,000/yr in cash flow (all in 2012 dollars), .

My stuff:

$250,000 in inheritance

Stable job, earn $132K/yr or 28% tax bracket while single (live in FL, no state tax)

Emergency funds: $16,250 sitting in a checking account, making next to nothing (still deciding what to do here to better store my emergency funds)

403B:
I am just now adding 17K to this. I had to wait till June in order to get the match after 1 yr of employment. They match $0.50 for every $1 up to 6%, and automatically put 1.25% of salary with 100% vested interest after 3 yrs.

Here are low cost funds available to purchase…

Low ER funds:
Vang Tot Bnd (VBTSX) - tracks the Barclay Cap Aggregate Bnd Index - ER 0.11%
Vang Instl Index (VINIX) - tracks the standard and poor 500 - ER 0.04%
Vang Md-Cp Idx (VMISX) tracks the MSCI US Mid Cap 450 Index - ER 0.12%
Vang Dev Mkts (VDMAX) - tracks MSCI EAFE Index - ER 0.12%

Others to consider:
Vang Windsor II (VXNAX) - Large and Mid-Cap Value - ER 0.27%
Vang SC Val Idx (VISVX) - track the MSCI US Small Cap Value Index - 0.37%
Vang SC Growth (VSGIX) - tracks MSCI Small Cap Growth Index - 0.08%

My plan was to use the 17K (really about $20,960 after match) with this split and without taking out expense:

38% in VDMAX ($7,964)
25% in VINIX ($5,240)
25% in VMISX ($5,240)
12% in VBTSX ($2,515)

What I have so far:

Roth IRA:
BND Vanguard Total Bond Market Etf $10,193.04
VNQ vanguard reit index fund $5,506.23

Rollover IRA:
vanguard total stock market index fund (VTI) $33,648.64

Taxable account:
vanguard small-cap value index fund (VBR) $11,579.34
Vanguard Intl Equity Ind Fd (VEU) $47,238.40
vanguard total stock market index fund (VTI) $2,917.12

What it looks like at the end of this year if goes as planned:
Name Dollar amount % of total Total dollars
vti $36,565.76 28% $132,041.77
vbr $11,579.34 9% Total breakdown
veu $47,238.40 36% 44% US stocks, 44% International stocks, 10% Bonds, 4% REITs
bnd $10,193.04 8%
vnq $5,506.23 4%
vdmax $7,964.00 6%
vinix $5,240.00 4%
vmisx $5,240.00 4%
vbtsx $2,515.00 2%

Real estate:
I own a recently rehabbed duplex worth around $165K, paid $158,200 with 3% down on a FHA loan at 4.35% on Oct 2011. The remaining balance is $152,064. The monthly breakdown is $769.78 for the mortgage, $145.19 for PMI and taxes and insurance make a total of $1,199/month. It is a 3/2 that I rent out for $1,225 and I live in the 1/1. Once I move in with my fiancé (she wants to wait till after marriage even though there is a higher cost of living), I should be able to get $575-600 in rent. So about $1,800/mo rent for $1,200/mo PITI.

Also, I keep a CYA account in my checking of 6 months rent for each rental property (right now it is $7,358) for future maintenance.

Debts:

Student loans: $128,039.50 at 3.25%. Monthly payments are $631.38 ($7576.56) I have another 28 yrs on the loan.

I just started working for a non-profit hospital, which means I may be able to receive loan forgiveness on the remaining balance after 120 consecutive payments (10 yrs). I am also trying to lower my monthly payment in order to take advantage of this program. I chose a graduated increase in monthly payments to best take advantage of this program. Here is how my new payment structure will look like:

Period (years) Monthly Payment Annual Payments
1 - 2 $340.91 $4090.92
3 - 4 $365.58 $4386.96
5 - 6 $392.04 $4704.48
7 - 8 $420.41 $5044.92
9 - 10 $450.84 $5410.08

I own a 2006 scion tC (2 door, small car) free and clear. I plan on driving it for another 5 years or more if there are no major expense or if it becomes a hassle with future kids.

Credit score: 780-800

Her stuff:

Stable job, earns 40K/yr or 25% tax bracket (lives in FL, no state tax)

Emergency fund: none really. Has close to $1K in checking that she uses to stay ahead of bills. Mostly month to month.

401K previous employer: $12K

401K current employer: 4K

Right now, not maxing company matching. Company matches $0.50 for every $1 up to 6% in 401K.

No Roth IRA.

No student loans or cc debt

She owns a 3/2 SFH worth $115K, paid $112K with 10% down on a conventional loan at 4.75% in 2010. The remaining balance is $ 100,000. I’m not sure of her monthly breakdown, but is 1.5 yrs into her 30 yr note and does have PMI on her home as well. She was renting a room for $600/month, but no longer has a roommate. The house could rent for $1050-$1100/mo and cost about $850 PITI.

2006 Ford Explorer with 12 months of payments left at 9% interest.

Credit score: 760-780

I am encouraging her to try to save money (like let me buy dinners, etc.) to get the full match of her 401K and pay, contribute to Roth IRA. "My" money and "her" money won't become "our" money till after marriage, so that's when I will help accomplish these goals and bring her 401K in line with our overall investment plan. Right now she has active management on both her 401K’s.

Our plans:
After getting married (her parents are paying, we might have to chip in about 2K), we are going to initially move into her place. On one hand, it makes sense since my duplex can cover itself, including monthly payments going towards future expenses. With her mortgage being so low, it wouldn't take long to pay off the total balance. However, I would like to move to a neighborhood that is more convenient of a drive to work for the both of us, and has great public schools for future kids. While I'm not in a rush to buy a new place, with prices and mortgage rates so low, it's tempting to make that move now and add her place as a rental property as well. These houses range from 200-250K.

Another consideration... we will still have another 30K after tax, after cost of living money to invest after the 401K, 403b and both Roth IRA’s are maxed out (though this will be less once the kids come along).

My questions:

1) How would you use the inheritance? Pay off my place, her place, both places, student loans, her car, buy a new place to live in with all cash? Or just add to taxable account?

2) Would you try for some sort of hybrid... for instance, do a no cost refi on both places, put enough down to get rid of PMI on both places, change the loans from a 30 to a 15 yr. note, etc.

3) Real estate is still at a bargain in FL (my opinion)... would you use the $ to pick up a couple of rental properties? I can get a place for around 40-50K after rehab value that rents for $650-$700. I'm renting a place now (and have done so in the past), so I have some idea as to time/money invested of being a landlord.

4) Is my portfolio too aggressive with such a high foreign %, small cap tilt and low bond %? How would you adjust the asset allocation and/or location of the funds?

5) Would you do anything else for the emergency fund and CYA funds for the rental properties? CD ladder, I-Bonds, Money Market?

6) Have her do a rollover from previous 401K to a IRA?
Before you answer, we've discussed moving in together before marriage and she doesn't want to. We've also agreed on doing a prenuptial agreement.

Thank you so much for all of your help.

[Animorph]

1) Do pay off the car loan at 9% ASAP. I'm of the "don't pay off the low interest mortgage" persuasion so I'd keep the other low cost loans (per 2 below).

Max out your 401k's since you are in the higher tax brackets. Contribute any post-tax retirement savings (but not at the expense of pre-tax contributions) to max out Roth IRA's. Use the inheritance to help do this if your savings rate is not sufficient.

Invest the rest of the inheritance in a taxable account, keeping your same overall AA. However, you might want the bond portion in the pre-tax accounts to avoid taxes on them.

2) I'd refi to get rid of PMI. Go ahead and get 30 years at current low rates and invest during that time.

3) Given your plans for rentals, property now doesn't sound too bad, but I'm no RE expert. I'd just invest in my AA.

4) You're very close to my AA, and I'm retired (though DW isn't yet). If you handled the last 5 years without too much worry, then you should be fine.

5) I always kept enough cash to handle any unexpected immediate needs. After that I was happy to sell something out of the portfolio in an emergeny. Invest it, conservatively and in a separate account if you wish. You should have plenty of taxable account value after the inheritance to cover anything.

6) If she rolls over into an IRA she won't be able to do a backdoor Roth contribution. You are going to be close to the MFJ income limit for Roth contributions. It would be nice to preserve that backdoor option. You are kind of locked out of the backdoor option since you already have a rollover IRA. If her 401k really sucks, then roll it over and take the Roth hit. The IRA remains in her name only, so there should be no issues doing this pre or post marriage.

[pb4uski]

Wow. Most detailed introduction that I have seen on these boards. In the future, no need for pennies

You've got a great start. As to your questions, my POV (YMMV):

As I follow it the interest rates on your mortgages and student loans are pretty low, so I would leave that leverage in place (or refi the mortgages to slightly lower rates and add enough equity to get rid of PMI). The auto loan should definitely be paid off as you can't get 9% anywhere else.

Your AA target looks reasonable though I think the international equities component is too high, particularly considering that if you were to drill down into a US stock fund you would see a lot of earnings from international operations of US based companies in the index. I would scale that back to ~25% or go with an all-world fund for the equity component.

Once you're married, you are on top of having her maximize her 401k match, you maximizing your 403b match, making contributions to Roths to the extent that you can. In addition to a target AA, you might want to have targets for taxable funds, tax-deferred funds (401k, 403b, tIRAs) and tax-free funds (Roth IRAs, HSAs, etc). Speaking of which, if either of you have access to HSAs they are a great adjunct to Roths as tax-free funds, you simply fund the max and then pay your medical expenses from taxable funds and let the HSA grow tax free (assuming that you later use the HSA for qualified medical expenses).

You would want to put your bonds and other investments that generate significant taxable income in your tax-deferred accounts. If you have any high income investments in your taxable accounts, you may want to consider munis.

On investment real estate, I think you need to decide an "investment policy", how much of your total investable assets you want devoted to real estate, how much locally, how much in REITs, how much financing on each property (I would suggest ~70-75%), etc as these decisions will drive how many properties you buy locally. In doing this I would look at the equity amount as the investment. Also keep in mind that while you have the time to manage the properties now that once you're married and busier in your job and little ones come along that you will have less time available to managing real estate.

If both your jobs are stable I think your emergency fund is fine at ~15k since you have other assets that could be accessed if needed. I would put it in an internet savings account (TIAA Direct is offering 1.24% IIRC but that is an introductory rate and could decrease).

Since you're into Vanguard (me too) and are into planning, I suggest that you have them prepare a financial plan for you if you can get it free or at a substantial discount. While their process does have some warts, it would be another view to consider as you plan your future.

On the inheritance, follow your AA after paying off the car loan, etc.

Good luck.

[pb4uski]

Quote:

Originally Posted by Animorph ....If she rolls over into an IRA she won't be able to do a backdoor Roth contribution. You are going to be close to the MFJ income limit for Roth contributions. It would be nice to preserve that backdoor option. You are kind of locked out of the backdoor option since you already have a rollover IRA. If her 401k really sucks, then roll it over and take the Roth hit. The IRA remains in her name only, so there should be no issues doing this pre or post marriage.

+1 I was thinking the same thing.

[joerh]

Thank you for the replies.

I agree with leaving the student loans in place, especially if I get the loan forgiveness in 10 years. I also agree with holding the mortgages on the real estate, as long as I can get that rate low. What I struggle with is... what is low enough? < 4% seems to be where I'm at to give up guaranteed money by paying off the loan, though other things like tax savings, cash flow, condition of the property, etc. come into play. But getting rid of the PMI is a priority of mine at this time.

My job has a flex spending account, but not a HSA. I'll have to check on her account. She is suppose to be getting me all that kind of information in the next week or so.

Good advice about the backdoor Roth contributions. I just got promoted to this pay scale, so the backdoor Roth isn't something I've looked too much at.

As far as the real estate goes, I know it's work. So I only will buy if the numbers work... (Rent Rate)/(2) - ($ mortgage) - ($100 monthly cash flow for me) < or = $0. That gives me a built in cushion for vacancy, taxes, insurance and future cost, and allows me to add to my CYA Real Estate Account (6 months rent) up front. As rents increase hand it over to a management company and spend more time with the family. That's the plan anyway. We'll see how that works out.

I'll look into some of the other online account for me EF. Are I-bonds worth purchasing for my EF? Even if I still may be working at a high tax bracket after 30 yrs?

Thanks

[rodi]

Some questions about the inheritance.
Is it in taxable form, or is it an IRA or other retirement account?
The reason I ask is that what you do with it can make a big difference tax wise.

I inherited an IRA and it's still in an IRA. Because my father was above 70, he was already drawing RMDs - so I take a small RMD (based on my age) each year. For me, that's a convenient source of income for the kids 529 funds. I can invest it as I want - but must take the RMD, and pay taxes on that withdrawal, each year.

If I'd cashed out the whole thing I would have owed taxes on the whole thing that year. Not a great situation. As it stands, this is a source of funds for my ER to tide me over till my 401k/IRA/SS start. I just have to pay income taxes on it as I withdraw funds.

Another point - you might not want to hear... Keep the inheritance in your name. Life is unpredictable, and if you comingle the funds *and* the marriage doesn't work out, you've lost half. I'm a hopeless romantic, but it's good to be practical. This may vary by state, though... check the laws in your state. Our marriage is based on sharing assets... Our budget is for both of us and assumes all funds are available... but the inherited IRA is in my name. You never know what the future holds.

[joerh]

Thank you for your reply Rodi. I spoke with my brother (head of the trust, getting the same deal as me, and happens to be a CPA). Here's what he said...

"All grandma's assets that were owned by the trust were liquid, except the house, at the date of here death. So for tax purposes there will be a couple items to consider, but all are tax beneficial.

The house was valued at $275,000 at date of death so that is our basis in the property. So if we sell it at a $100,000 loss you will get to claim the long term capital loss of your % of that amount.

Cash - no gain or loss on cash.

The IRA that he was referring to all went through the estate and was our uncle's money. I would be curious what he meant by "taxable form"? There can be tax issues if you get an inheritance as a function of law (right of survivorship, etc.) but it all went through her estate / trust and was stepped up at the date of death.

Short answer - these will be after tax dollars."

I'm guessing it was the job of the estate that may have put this inheritance as a more tax friendly disperse than yours? Not sure.

I already talked to her about a prenup and going into it with what's ours, etc. I am going to give one of my attorney friends a call to see if they'll help write something up as a wedding gift.

It's along those same lines of not knowing for sure what the future holds is why I'm not paying off her car loan, or gifting her money to help max out 401K till we're married. I was also leaning towards paying off my student loans with it, since she probably won't end up with half my student loan debt if we divorce. But like I said in my last post, the student loan forgiveness is too sweet a deal to pass up. Plus I'm also betting heavily on us, or I wouldn't marry her at all.

[rodi]

Sounds like you've got everything covered.
I actually like the fact that the bulk of my inheritance was in an IRA. I don't pay taxes on the dividends/cap gains... just on the RMD withdrawals... which aren't that big... and it is a nice source to tap to provide the income stream (or part of it) when I RE in a few years. My 401k is untouchable till 59.5... so it's nice to have an "early" shot at a 401k equivalent.

[Gatordoc50]

Sounds like you've got a plan and a strategy to implement the plan. Personally, I wouldn't invest the 250k in one lump sum in the market. One might invest in long term tax free bonds and invest the interest in a Roth for each of you. Over 25 years you would have funded each of your accounts with a total of 250k and still have the 250k initial investment. I would be pretty aggressive in the Roth.

[Aviator]

Sorry for your loss. Your grandmother was very wise to establish an estate plan.

Remember the KISS principle. LBYM. Pay off your loans, mortgages, etc and remain debt free. Don't get too creative with various investment vehicles.

You might consider posting your same question over on the Bogleheads forum.

[joerh]

Quote:

Originally Posted by Aviator Sorry for your loss. Your grandmother was very wise to establish an estate plan. Remember the KISS principle. LBYM. Pay off your loans, mortgages, etc and remain debt free. Don't get too creative with various investment vehicles. You might consider posting your same question over on the Bogleheads forum.

I posted there first, and then copy and pasted it here minutes after. Good advice from both places. Most agree to pay off the car and get rid of the PMI. After that, it's kind of all over. But that's kind of what I expected, investing vs paying off those low interest rates is always a back and forth arguement.

[joerh]

Quote:

Originally Posted by Gatordoc50 Sounds like you've got a plan and a strategy to implement the plan. Personally, I wouldn't invest the 250k in one lump sum in the market. One might invest in long term tax free bonds and invest the interest in a Roth for each of you. Over 25 years you would have funded each of your accounts with a total of 250k and still have the 250k initial investment. I would be pretty aggressive in the Roth.

Never thought of that. It seems that would be a pretty conservative move, maybe too conservative?

[growing_older]

I'm not at all sure I would want to avoid the stock market by investing a large lump sum into long term bonds when interest rates are at historic lows. I suspect that would turn out to be a risky move.

If you have a sense of risk tolerance and an asset allocation you are happy with, you can either invest it accordingly, or park it in a money market and dollar cost average it into your target allocation over some months. Personally, I would pay down enough debt to get rid of PMI. Or go talk to the Bogleheads about a simple index fund portfolio.

[clifp]

Excellent introduction.

I think you have a very good handle on your finances congratulations. I think your strategy of having rental properties is also fine. It appears that FL (like Vegas where I have been buying properties) you can get significant positive cash flow. I also think that these rock bottom interest rates are likely to be once in a lifetime opportunity and there is a very good chance in 10 or 15 years you'll be happy to have these cheap loans.

None the less it is important to minimize interest rates cost and not go crazy with leverage, perhaps no more than 3-4 rentals plus your personal house for a while. Obviously getting rid of the auto loan is high priority. I would also take advantage of the especially low rates for owner occupied house with 20 or 25% down. So I would refi yours and then hers after you are married. You may even look at 15 year loans which are down at 2.75%.

I'd also suggest considering purchasing "our" home with cash. In hard hit places like Arizona, and Vegas the real estate market is become a seller market and cash buyers are able to get a discount and having a much easier time getting what they want. Not sure FL is that way yet. You then would then finance the house as needed say right before you purchase the next rental.

[pb4uski]

Quote:

Originally Posted by growing_older I'm not at all sure I would want to avoid the stock market by investing a large lump sum into long term bonds when interest rates are at historic lows. I suspect that would turn out to be a risky move......

+1 Long term bonds scare me right now. While i don't see interest rates rising imminently, they will eventually and I'm not sure if I am astute enough to call when and I wouldn't want to take the hit in fair value, so I'm in shorter duration bond funds at this point.

[Gatordoc50]

Quote:

Originally Posted by pb4uski +1 Long term bonds scare me right now. While i don't see interest rates rising imminently, they will eventually and I'm not sure if I am astute enough to call when and I wouldn't want to take the hit in fair value, so I'm in shorter duration bond funds at this point.

Agreed. I'm talking about individual bonds. If equities going forward approach historical returns then you will benefit from investing your tax free earnings into the Roth being aggressive in the Roth.

[Gatordoc50]

Quote:

Originally Posted by joerh Never thought of that. It seems that would be a pretty conservative move, maybe too conservative?

You won't hear about that strategy. The govrrnment doesn't get paid because you are in tax free bonds. That is,individual bonds. The broker gets paid once, only when you purchase the bonds. And you get tax free growth inside your Roth and tax free withdrawals. If you invest the money outside of a retirement account the only guarantee you are getting is taxes, taxes, and more taxes. You can always do a combination, too. Half in bonds, half in stocks. The whole reason I presented this option is that I knew it wouldn't come from too many others.

[Gatordoc50]

Quote:

Originally Posted by growing_older I'm not at all sure I would want to avoid the stock market by investing a large lump sum into long term bonds when interest rates are at historic lows. I suspect that would turn out to be a risky move. If you have a sense of risk tolerance and an asset allocation you are happy with, you can either invest it accordingly, or park it in a money market and dollar cost average it into your target allocation over some months. Personally, I would pay down enough debt to get rid of PMI. Or go talk to the Bogleheads about a simple index fund portfolio.

Long term individual bonds. And money markets come with no guarantees either, except futile returns.