How to best spend a windfall/inheritance? Need help, please advise.

[JK]

Here is my current financial situation:
-I am a current 29yo, PGY-2 medical resident (soon to be PGY-3) with annual salary ~53k/yr with about another 26 months until residency completion. Expected earnings ~350-400k/yr upon graduation with likely salary increases afterwards.
-My spouse currently works full time and earns ~100k/yr.
-We are very frugal thus far and have a great savings rate around 30-50% (post-tax) the past couple years. For the first time, last year we maxed out both our 401ks (18k each), Roth accounts, and HSA as well as have been paying down my student loans.
-Current financial situation: approximately 114k in student loans (refinanced at 3.2% variable rate), 150k in combined investments (all tax protected). 20k in combined checking/savings emergency fund.
*We just received an inheritance of 225k and need to decide how to best utilize it.
*Upcoming expenses: likely need to purchase a new/used car within the next 3-4 months (20-25k). My wife is pregnant and due with our first child in November. That will undoubtedly result in a large uptick in our annual expenses, but the biggest contributor will be my wife decreasing to 1/3 or 1/2 time.

I am having a dilemma as to how best to deploy the 225k inheritance and would appreciate insight because I know we will not be able to max out all our retirement accounts with her at part time. I'm trying to decide between two options.

-Option #1: Pay off student loans first thing leaving approximately 110k left. Max out both Roth IRAs for 2015 resulting in 100k left. Put the balance into a high yield savings account (such as in an online bank account like "Ally bank") which will be used for upcoming purchases. We will then utilize this extra money to help pay for living expenses over the next two years. This will then allow us to take advantage of all our tax protected accounts because we will be eating into the savings, thus allowing us to put more of our salary into the tax sheltered accounts.

-Option #2: Still pay off student loans and max out 2015 Roths leaving 100k remaining. Only difference in this scenario would be to add to our emergency fund (additional 20k or so) and invest the rest into a taxable account. This would have the benefit of getting money into the market now and allowing it to grow. The downside is that we likely wouldn't be able to max out our tax protected accounts over the next two years because we would be using our paychecks to pay for typical expenses.

Essentially, the question boils down to...invest in taxable accounts today, or have the ability to invest in tax advantaged accounts over the next couple years? Personally, I'm leaning towards option #1 so I can continue to max out tax advantage accounts. Any and all thoughts would be appreciated!

[The White Coat Investor]

False dichotomy. You can do both. Invest it in taxable now and gradually move it into the tax-protected as able.

[phw]

Neither.  Pretend you didn't get it.  Do not let it inflate your spending or living expenses.  Decrease your spending to match your decreased income for the very short amount of time until you're done with residency.  Number one rule for rich people to stay rich "Never spend the principle".  Think of this inheritance as a tool to make future money, not as money to spend.

For instance, you "need" a $20-25k used car as a resident?  How about a really nice $5-8k car to keep living as a resident?

[MrsIMDoc]

phw wrote:

Neither.  Pretend you didn’t get it.  Do not let it inflate your spending or living expenses.  Decrease your spending to match your decreased income for the very short amount of time until you’re done with residency.  Number one rule for rich people to stay rich “Never spend the principle”.  Think of this inheritance as a tool to make future money, not as money to spend.

For instance, you “need” a $20-25k used car as a resident?  How about a really nice $5-8k car to keep living as a resident?

Click to expand...

It sounds like he is planning to use this inheritance to invest/pay off loans, so how is "pretending you didn't get it" good advice?  He is asking for the best way to as you say, "use the inheritance as a tool"?

Regarding the car, if he is purchasing a reasonable car in cash for $20,000 why would you fault him? They have a combined income of $150,000 and have the cash for the car. With a growing family it would make sense if he wanted to purchase either a "newer used" car or a new car at that price.  As long as he is not financing the car, which it sounds like he is not, I do not think that is a bad decision.

[phw]

MrsIMDoc wrote:

phw wrote:

Neither.  Pretend you didn’t get it.  Do not let it inflate your spending or living expenses.  Decrease your spending to match your decreased income for the very short amount of time until you’re done with residency.  Number one rule for rich people to stay rich “Never spend the principle”.  Think of this inheritance as a tool to make future money, not as money to spend.

For instance, you “need” a $20-25k used car as a resident?  How about a really nice $5-8k car to keep living as a resident?

Click to expand…

It sounds like he is planning to use this inheritance to invest/pay off loans, so how is “pretending you didn’t get it” good advice?  He is asking for the best way to as you say, “use the inheritance as a tool”?

Regarding the car, if he is purchasing a reasonable car in cash for $20,000 why would you fault him? They have a combined income of $150,000 and have the cash for the car. With a growing family it would make sense if he wanted to purchase either a “newer used” car or a new car at that price.  As long as he is not financing the car, which it sounds like he is not, I do not think that is a bad decision.

Click to expand...

You are incorrect, he is not using the inheritance purely to invest or pay off debt (which would be using the tool, btw).  he clearly states in #1 ".....will be used for upcoming purchases. We will then utilize this extra money to help pay for living expenses over the next two years"  and in #2 he states, "we likely wouldn’t be able to max out our tax protected accounts over the next two years".  They also won't have an income of $150k, they will have an income of maybe $100k, based upon his wife "decreasing to 1/3 or 1/2 time"....which is still a lot more money than many other resident families live on, and should be enough to still use tax advantaged savings accounts.

which is why I say neither and I "fault" him on spending so much on a car.  IMHO he should not use the inheritance for living expenses and he should not stop maxing out retirement accounts.  He should live within the means that he has, and invest ALL of the inheritance, either in debt paying 3.5% guaranteed, in a taxable account paying market returns, or in a cash emergency fund paying about 1%....whatever.  But, the money should not be spent now, and they should not stop maxing their tax-advantaged accounts.....imho.

JK, what would you have done if this inheritance didn't show up?  Do that.  Well, assuming "that" doesn't mean spending 20% of your annual gross income on a single car (not including, gas, insurance, repairs, taxes etc).

 

 

[Zaphod]

MrsIMDoc wrote:

phw wrote:

Neither.  Pretend you didn’t get it.  Do not let it inflate your spending or living expenses.  Decrease your spending to match your decreased income for the very short amount of time until you’re done with residency.  Number one rule for rich people to stay rich “Never spend the principle”.  Think of this inheritance as a tool to make future money, not as money to spend.

For instance, you “need” a $20-25k used car as a resident?  How about a really nice $5-8k car to keep living as a resident?

Click to expand…

It sounds like he is planning to use this inheritance to invest/pay off loans, so how is “pretending you didn’t get it” good advice?  He is asking for the best way to as you say, “use the inheritance as a tool”?

Regarding the car, if he is purchasing a reasonable car in cash for $20,000 why would you fault him? They have a combined income of $150,000 and have the cash for the car. With a growing family it would make sense if he wanted to purchase either a “newer used” car or a new car at that price.  As long as he is not financing the car, which it sounds like he is not, I do not think that is a bad decision.

Click to expand...

A car should probably not be more than 10% of your income. I know this drops many peoples cars to pretty terrible levels, but otherwise its an awful waste of money. A reasonable 20k car? You can get very nice cars for the 10-15k range, 20k is wasteful at this level. Remember, your car sits unused and a waste of value 95% of the time or more.

I just had an email last night from a dealership and there was a 2012 BMW something, looked very nice, 80k mile iirc, and it was 12.5k. Certainly one can find a reliable and less flashy car for similar or better year, mileage, whatever.

[jfoxcpacfp]

Option #1 - Pay off student loans, max out Roth IRAs, pay cash for car, and use enough of the inheritance to fund 401k contributions at a tax savings of 25% + your state bracket.

After your wife goes part-time, I would suggest contributing only enough to 401k's to get you to 15% federal bracket then put whatever you will not spend in the next 5 years in taxable accounts, the rest in high-yield checking/savings.

[JK]

Thanks for the input...although I feel like some of the responses have gone in the wrong direction and didn't really answer the question I posed and were more focused on a car. To answer some of the questions listed above.

-I am not set on a $20-25k car. I just put that number up there and would hope to avoid that as being a focus of this post. The goal is to get a safe SUV with 4 wheel drive for my wife and baby (we live in Michigan). Whether that is a purchase from a parent, friend, dealership has not been looked into yet. I'm hoping to get one for 5-15k but I conservatively put other numbers up there in the post.

-As to what I would do without the inheritance... Our likely salary will drop to ~75-100k. However, additional expenses for daycare (when my wife does work), diapers, nursery, etc... would significantly increase our costs. We'd also have a larger emergency fund. Only the leftover money would be put in tax protected accounts when possible. However, paying for all that, a car, and still maxing out retirement accounts (18+18+6.5+5.5+5.5 last year) is just not feasible. We also just purchased life insurance on both of us so add that to the mix which we didn't have last year and would still have student loans that we're paying.

I hope this clarifies some of the questions/posts above. Really, the question (after all expenses paid) is to invest the balance NOW in taxable accounts or LATER in tax protected accounts.

I do appreciate all the input. Thank you.

 

[Zaphod]

Like WCI said, its not either/or. I would map it all out and see which way accomplishes the most good across the spectrum rather than a on/off comparison. One thing that you touched on but didnt elaborate on is cash flow. There is definitely a balance in there that from a cash flow perspective is going to make the most sense.

I had a similar situation recently with more tax deferred space, choice was to put double away from now, but it saved a relatively minor amount of taxes (since it dipped into the lower marginal rate) but severely limited cash flow in case of an emergency. I chose taxable instead since the tax diff was minimal and the liquidity much much higher. This is probably the right way to view your situation (cash flow, not taxable), and will help clarify where the money goes first.

Also, you're not going to be in a very high bracket anyway so more tax advantaged isnt going to be that much of an advantage in your case.

[Sneezy]

I would consider NOT paying off your student loan right away

It is low rate and your are facing 2 relatively low earning years (compared to both current and future earnings).  You are also facing some uncertainty about exactly what expenses/income will be those 2 years.

I'd max out the Roths, buy a reasonable car and keep the money available in case your plans change.  If for whatever reason (health issue, preference, employment issue) you and your wife decide you want her to stay home full time you'll have the money to bridge until you are an attending.  If things go as you plan, you can just pay off the loan when you become an attending.  Waiting that 2 years gives you a lot of flexibility just when you may need it

 

 

[Medical Bartender]

I am a bit curious as to what job, after chief year, will be pulling down 350-400k as a medicine attending. You should point me in that direction

Anyway, I would take option #2. I support your desire to pay off the loans. Paying them off will free up your cash flow and help offset your impending loss of salary and increased month to month expenses.

[AlexxT]

I would buy the car, pay off my loans, and keep the rest in a money market account until I finish my training. There will only be around 80k left, and there's nothing wrong with adding that to your emergency fund for now.  You will have expenses when you relocate after residency, and the extra liquid money will come in handy.   After that, max out the retirement accounts and fund your 529.  If you don't want all of that money sitting around, you can invest some of it in the 529 in November after the baby is born.  A 529 works like a Roth, with after tax dollars growing tax free, no taxes on withdrawal if used for higher education.   You can contribute $14,000 per donor per child per year, and you can front load for 5 years.  That means you have an additional $140,000 of tax deferred space to fill any time over the next 5 years

There's nothing wrong with paying off your loans if that's what you want to do.  Yes, you're only getting 3.2% return on that, but that's guaranteed and way better than bonds are paying, and you'll feel better and be able to save more every month ( aka improved cash flow).

There's nothing wrong with getting a better car, or a new car. New cars cost more for very good reasons. (less chance of it being a lemon, lower mileage, and you get the newest safety features)  If you're planning on having more children, consider a minivan.  I was going to suggest a Honda Odyssey, but if you need 4 wheel drive, you have to go with the Toyota Sienna, as the Odyssey doesn't have 4 wheel drive.

 

 

 

[YYjames]

Curious as well - "medical" resident to be attending making 350-400k ?

Very few fields nowadays have that kind of salary.

[The White Coat Investor]

YYjames wrote:

Curious as well – “medical” resident to be attending making 350-400k ?

Very few fields nowadays have that kind of salary.

Click to expand...

I've always been impressed with how much variation there is in a single field. I know emergency docs making $120K and I know emergency docs making $600K. I'm sure many fields are similar. It depends on the type of practice, where it is, how hard you work, etc.

[Allonblack]

Nothing wrong with buying a 20k car in his situation. He's in a good enough financial place that a degree of consumption leveling is totally rational. It's not like his life is going to be so much better in two years or retirement because he drove a wreck until he graduated residency and put the rest in an index fund.