125,000 Inheritance--what to do with it?

[Crystal1588]

Hi All-
My grandpa recently passed away and left me $125,000. We are in good shape financially, so I’m not exactly sure what to do with the money.  We plan on just sitting on it for a while as to not make any rash decisions, but was also looking for some input of where to put it.
Info:
Life Situation: Hubby (30) plus me (29) and 3 kids (4,2 and 3 months)  Married filing Jointly

Gross Salary/Wages: Husband makes $87,000 and I make about $15,000 working 2 days/week. Much of that $15,000 is eaten up by daycare but I love my job and want to stay working 2 days/week. Also, the 401k match is awesome so we try to take advantage of contributions.

Current Savings Contributions:
401k-DH contributes 6% ($5,200) and his company matches 5% for a total contribution of $9,600. This is a new benefit in 2017
         I put in 60% of my pay ($9,000) and my company matches 25% of all contributions for a total of $11,250
         Total contributions to 401k: $20,850
Liquid Savings: Currently we save about $500/month into our general liquid savings.

HSA- DH has access to a HDHP and an HSA this year.  His company puts in $1,000 and we will be putting in $6,700 for a total contribution of $7,700

Rental Income: We own a rental property that brings in $400/month after all expenses. This goes straight into a savings account for future rentals/repairs so we don't count it as income.

DH's Side Gig: He runs a resale shop on Ebay. Currently pulls in an average of $500/month but can obviously fluctuate widely. We currently save this money in our rental account.

Current Liabilities:
Mortgage (just refinanced to 3.5%) so 30 years remaining: Balance of $274,000. PITI payment is $1700/month
Rental Mortgage rate of 4%, 27 years remaining: Balance of 44,000

Current Savings/Assets
House: Worth $350,000
Rental Condo: Worth 90,000
My Traditional IRA: $7,205
DH's IRA: $51,000 in Vanguard
My 401k: $70,000
Rental Account: Current balance $15,000 in Capital One earmarked for new rentals or repairs on the current one.
General Savings Account: $5,000
Kids 529s: Total balance of $5,000

Basically, we save about $225/month into the kid’s 529s (total). We add to our 401ks, max out IRAs (started doing this last year) and add about $500/month into regular savings from our paychecks. We also add about $1,000/month into our rental savings from the rental income and ebay side business. We’re comfortable with our expenses, budget and savings and want to maximize how we use this windfall.  I will be increasing my 401k contribution to 100% to maximize the match I get, but after that, what should I do? Increase my husband’s 401k to maxing even though there is no match?  Just stick it in an index fund? Other?

[MayDay]

Definitely increase your husband's 401k to the max, to reduce your taxable income.

[ysette9]

If you haven't read it already, this Bogleheads wiki article may help you think through how to respond.

https://www.bogleheads.org/wiki/Managing_a_windfall

[CheapScholar]

Definitely what MayDay said - up the 401K.

[Iplawyer]

Definitely increase your husband's 401k to the max, to reduce your taxable income.

I disagree completely - the 401Ks should only be maxed out to the amount of the match at their tax level - which should be well under the 15% range.   So if she could up hers and it is still 25% matched  - she should.  But if he upped his and it wasn't matched - then they shouldn't.  Their tax level now is very low. 

[terran]

HSA- DH has access to a HDHP and an HSA this year.  His company puts in $1,000 and we will be putting in $6,700 for a total contribution of $7,700

The limit is across all contributions (employee and employer), so don't go over the $6750 limit assuming you have family HDHP coverage.

Definitely increase your husband's 401k to the max, to reduce your taxable income.

Are you saying not to defer taxes in the 15% bracket? Or something else?

I would agree with those saying to max out all available tax advantaged accounts and use the inheritance to make up for the lost income for living expenses (essentially transferring the inheritance from taxable to tax advantaged) with a couple of caveats:

1) Be careful not to tax defer so much that you are putting money in retirement accounts that wouldn't have been taxed anyway. I don't think this should be a concern, but tax non-refundable tax credits (like the savers tax credit) can do some funny things at lower income levels. I think most of the tax credits for having kids are refundable, so they could actually give you a negative tax liability (money back). There are also always Roth IRAs that won't reduce your taxable income, but are still worth using.
2) At least in some states inherited money can be excluded from divorce proceedings, but only if it is never commingled with marital assets (in other words, if you keep the money in an account that is only in your name). I know it's not the most pleasant thing to think about, but since it was your grandfather's money and he gave it to you it's something worth thinking about and you only have one shot at this: once it's commingled that's the end of it.

I disagree completely - the 401Ks should only be maxed out to the amount of the match at their tax level - which should be well under the 15% range.   So if she could up hers and it is still 25% matched  - she should.  But if he upped his and it wasn't matched - then they shouldn't.  Their tax level now is very low. 
[/quote]

[terran]

Definitely increase your husband's 401k to the max, to reduce your taxable income.

I disagree completely - the 401Ks should only be maxed out to the amount of the match at their tax level - which should be well under the 15% range.   So if she could up hers and it is still 25% matched  - she should.  But if he upped his and it wasn't matched - then they shouldn't.  Their tax level now is very low.

Ah, I see what you're saying now that you edited. Being in a low bracket doesn't really matter. What matters in the marginal bracket now vs retirement. So if they expect to be in a higher bracket in retirement -- probably the 25% bracket (which would require around $100k of income and withdrawals), then you would be right, but otherwise the worst case is they pay the same 15% on the way out as they would now.

[JustGettingStarted1980]

My 0.02$

I agree with above to Max both 401K's to the level that would lead to 0$ in Tax liability. Do the math as this will be worth it for you.

As the limit to Max 401K's is 18 K each, that would allow you to contribute an extra 36K-20K =16K to your retirement per year at current spending levels for almost 8 years if you wanted to use all 125K Inheritance for this.

Another option is to use 80K to max the 401K's for the next 5 years, and then to use another 25-30K to buy another Rental, if that's what you are into. Would recommend keeping a large amount of extra cash (at least 15K again) for repairs and such just like you already have been doing.

Best of luck, hope this helps!

[Dicey]

I'm not a tax expert, but why funnel a non-taxable inheritance into a 401k that's going to have higher tax implications upon withdrawal?  My vote is to put it into low cost, taxable equities or additional rental property.
Under no circumstances would I throw it at either of those cheap mortgages. Also, I'm sorry for your loss. I hope you have lots of wonderful grandpa memories.

[Guesl982374]

I'm not a tax expert, but why funnel a non-taxable inheritance into a 401k that's going to have higher tax implications upon withdrawal?  My vote is to put it into low cost, taxable equities or additional rental property.

I believe the line of thinking is the OP is not maxing out their non-taxable accounts right now and by using some of this money for living expenses, they could increase their non-taxable contributions lowering their tax base.

[Iplawyer]

I'm not a tax expert, but why funnel a non-taxable inheritance into a 401k that's going to have higher tax implications upon withdrawal?  My vote is to put it into low cost, taxable equities or additional rental property.
Under no circumstances would I throw it at either of those cheap mortgages. Also, I'm sorry for your loss. I hope you have lots of wonderful grandpa memories.

Agreed completely.  First - they are likely only in the 15% bracket now considering their income, 3 kids, and mortgage.  Everyone expects the tax rates to go up eventually - they have to.  They are likely paying less now than they will pay in the future - so unless there is a Roth option at one of their places of employment  - I would keep the money outside of tax and penalty incurring accounts.

[dougules]

Why not throw most of it at the mortgage(s)?  At 3.5% and 4% that seems like it would be the best bet given returns on everything else are only so-so at the moment.

And I'm not sure how we got off on 401k from this. 

[CheapScholar]

A big question is, what age does OP envision retiring?  If it's in 50s then the 401Ks make a lot of sense.  Obviously there will be no penalties at 59.5 and you'd think that someone on this forum plans on living relatively frugally and not having a high marginal tax rate in retirement. 

[inline five]

I think you have some good options. If I personally were in your shoes I would pay down the mortgage on the rental enough to refi to a 15 year and purchase as many rentals as you can with 15 year mortgages. Instead of making $400/month you'll be cash flowing maybe only $200/month but the pay down on the mortgage will be substantially faster on the back end. That's probably the best way to build wealth in your situation.

[Iplawyer]

Why not throw most of it at the mortgage(s)?  At 3.5% and 4% that seems like it would be the best bet given returns on everything else are only so-so at the moment.

And I'm not sure how we got off on 401k from this.

Me either.  But instead of contributing to IRAs - they should be contributing $5500 each to Roth IRAs every year.

[Drifterrider]

Put it in a savings account for six months.  This will give you time to consider your options and time to not do something stupid.

[HPstache]

HSA- DH has access to a HDHP and an HSA this year.  His company puts in $1,000 and we will be putting in $6,700 for a total contribution of $7,700

FYI That is over the allowable combined contribution limit of $6,750 for a family HSA

[Catbert]

Another vote for NOT paying off mortgages.

Another option not already mentioned is to frontload the 529 plans.  While I'm personally am not a major fan of 529s, you obviously have a different opinion since you are funding them.  Think about front loading them and being able to tell your kids great-grandpa funded your education.  Then you can funnel the monthly money  into 401Ks or mutual funds in a brokerage account.

[Dicey]

I'm not a tax expert, but why funnel a non-taxable inheritance into a 401k that's going to have higher tax implications upon withdrawal?  My vote is to put it into low cost, taxable equities or additional rental property.

I believe the line of thinking is the OP is not maxing out their non-taxable accounts right now and by using some of this money for living expenses, they could increase their non-taxable contributions lowering their tax base.

This is, in fact, the opposite of what I was suggesting. Iplawyer understands what I'm getting at:

I'm not a tax expert, but why funnel a non-taxable inheritance into a 401k that's going to have higher tax implications upon withdrawal?  My vote is to put it into low cost, taxable equities or additional rental property.
Under no circumstances would I throw it at either of those cheap mortgages. Also, I'm sorry for your loss. I hope you have lots of wonderful grandpa memories.

Agreed completely.  First - they are likely only in the 15% bracket now considering their income, 3 kids, and mortgage.  Everyone expects the tax rates to go up eventually - they have to.  They are likely paying less now than they will pay in the future - so unless there is a Roth option at one of their places of employment  - I would keep the money outside of tax and penalty incurring accounts.

And because it bears repeating: Do NOT pay down those cheap mortgages!

Why not throw most of it at the mortgage(s)?  At 3.5% and 4% that seems like it would be the best bet given returns on everything else are only so-so at the moment.

Not sure what dougules has invested in that is only so-so, but my balanced portfolio is performing way above 4%. Comparing "at the moment" returns (?) to mortgages with rates that can never go up is totally apples to oranges.

[Rocketman]

Get a Roth IRA for each of you $5500 per year - $11k for both. Use the money to fund those for the next several years.  When you retire you want both kinds of investments- some you need to pay taxes on and some you don't.

[myrrh]

Get a Roth IRA for each of you $5500 per year - $11k for both. Use the money to fund those for the next several years.  When you retire you want both kinds of investments- some you need to pay taxes on and some you don't.

I agree, and recommend two $5500 Roth IRA contributions before April 15 for 2016 and then two additional $5500 contributions for 2017. Then you only have to figure out what to do with $103k. ;)

[Aggie1999]

Get a Roth IRA for each of you $5500 per year - $11k for both. Use the money to fund those for the next several years.  When you retire you want both kinds of investments- some you need to pay taxes on and some you don't.

Putting what money you can to a Roth IRA is good advise. I wouldn't hold onto the cash for years though just to fund the yearly Roth. Not sure if that is what you were saying or not.