What should I do with cash from Startup "Windfall"?

[asparagus]

Hello everyone,

I have been a long-time MMM reader, and am very interested to get the MMM community’s advice and combined wisdom on my situation.

Before I dive into specifics - I’ve been working for 5+ years, and I work for a small startup. My salary has increased about 2.5x since joining, and at the end of this year I will get a small chunk of cash because my company will get acquired. I also invest in tech startups on the side, but only a small % of my TNW. I am interested to hear everyone’s thoughts on what I could be doing better -- tax efficiency, long-term investment allocation, with both the cash from acquisition, 2020 taxes, and optimizing my overall 2021 tax/investment strategy.

Life Situation: Late 20s, single, no dependents, CA resident

Gross Salary/Wages: $145.6K ($140K salary, $5.6K 401K employer match)

Individual amounts of each Pre-tax deductions: 13K to 401K, healthcare paid by company.

Other Ordinary Income: None.

Qualified Dividends & Long Term Capital Gains:I will get $250K cash before the end of 2020 from the acquisition. I own common stock, am fully vested, and did an early exercise and an 83(b) election when I joined 4+ years ago. I think the long-term capital gains tax rate for the $250K should be 15% based on my income.

Rental Income, Actual Expenses, and Depreciation: None

Adjusted Gross Income: About $140K

Taxes: $45K for income taxes, SS, medicare, etc.

Current expenses: Averages about 3.3K - 3.7K.

Rent                 1,693
Utilities             130
Car Loan           355
Gas                  100
Car Insurance   115
Shopping          100
Haircut             50
Hobbies            100
Restaurants      300
Groceries          300
Misc                  70
Total                 3.3K

Total annual savings is $60.6K (145.6K - 45K taxes - 40K annual spending)

This savings is distributed roughly as:
401K, including employer match: 18.6K (13K employee* + 5.6K employer)
Wealthfront Post-tax Investment Account: $42K


Assets:

Cash:                           $15K
Wealthfront Brokerage: $74K
401K:                          $39K
Robinhood brokerage:   $14K
Angel investments in startups: $34K
Total Assets:                $166K + 2018 VW Golf

Liabilities:

Credit Card:       $2K (Full balance paid off each month)
Car Loan          $6K (2.2% APY, fully paid off by early 2022)
Total Liabilities:    $7K

[Re: optimizing tax on acquisition proceeds]
How can I minimize and/or defer any tax associated with the $250K proceeds? When do I actually pay the capital gains taxes, is it during filing season in 2021? And is there any way where I can further optimize my 2020 tax bill?

[Re: 2021 Investment Strategy]
In 2021, my annual income will be $200K, with a $7K annual 401K employer match. My spending rate will remain 40K. I plan to max out my 401K.

First of all, what should I do with the 250K cash? I have no plans to buy a house or make any large purchases. I intend to park all of it (after taxes) into my Wealthfront Post-tax Investment Account (90/10 stock/bonds). Is this the right move? I know that I could technically manage my portfolio myself… but based on MMM’s blog post, I am convinced that I should just let the robot do it for me!

Second -- How can I optimize my 2021 investment strategy? From my understanding, I should max out my 401K because it is a pre-tax contribution. At this point, I’m unsure what else to do. Can I contribute to a Roth or Traditional IRA? And if I were to max these out, how should I invest the remaining cash? Is there any way I can maximize pre-tax contributions? Again, I was thinking of plugging everything else into my Wealthfront Post-tax investment account.

I appreciate everyone’s advice, thank you and happy holidays!

[ysette9]

The simple and maybe annoying answer to your question is to just follow your personal investment plan. Don’t have one? Well, this is the time to write one. https://www.bogleheads.org/wiki/Investment_policy_statement

The idea is that provided you haven’t come into crazy life-changing amounts of money where you need to collect it anonymously and hire a team of lawyers to protect you from leeches, you should treat this windfall the way you treat the money you have to invest with each paycheck. You have a plan, a target asset allocation, so stick with it. If that isn’t good enough then soberly take some quiet time to reflect on your goals and risk comfort level and tweak your plan until it feels good.

There isn’t anything fundamentally different about investing $250k as investing $5k.

[zolotiyeruki]

tl;dr: Follow the Investment Order sticky.

Longer version:

You're single with a high income, which pushes you into higher tax brackets, for better or for worse.  You're paying 22% federal and 9.3% state marginal rates, so you'll want to minimize your taxable income.  Your income disqualifies you from contributing to an IRA, so that's out. 

In your shoes, I'd do the following:
1) Max out the traditional 401k.
2) Find out if your employer offers an HSA, and max that out (or at least heavily contribute to it)
3) Set up a backdoor Roth. (most people can)
4) Look into whether you can set up a mega backdoor Roth (this depends on your employer's 401k setup)
5) Invest the rest in taxable accounts.  Speaking of which, Wealthfront charges 0.25%. I don't know what other options you have, but you can get 0% fees over at Vanguard...

[mistymoney]

any way to max your 401k this year?

[asparagus]

Thanks everyone for your thoughtful replies. Some thoughts / questions based on your responses:

The simple and maybe annoying answer to your question is to just follow your personal investment plan. Don’t have one? Well, this is the time to write one. https://www.bogleheads.org/wiki/Investment_policy_statement

The idea is that provided you haven’t come into crazy life-changing amounts of money where you need to collect it anonymously and hire a team of lawyers to protect you from leeches, you should treat this windfall the way you treat the money you have to invest with each paycheck. You have a plan, a target asset allocation, so stick with it. If that isn’t good enough then soberly take some quiet time to reflect on your goals and risk comfort level and tweak your plan until it feels good.

There isn’t anything fundamentally different about investing $250k as investing $5k.

Thanks @ysette9, I will look into creating an investment policy statement. Broadly speaking, I have a 10-year financial plan with a personal P&L and balance sheet which factors in income growth, savings rate, and how much I allocate towards investments every year. However, I've been defaulting to allocating 90% of all investable funds into Wealthfront (90/10 stock/bond mix), with the remainder going to alternative investments (investing in startups). An IPS should provide a good set of "training wheels" to guide how I invest $ going forward. Thanks! 

tl;dr: Follow the Investment Order sticky.

Longer version:

You're single with a high income, which pushes you into higher tax brackets, for better or for worse.  You're paying 22% federal and 9.3% state marginal rates, so you'll want to minimize your taxable income.  Your income disqualifies you from contributing to an IRA, so that's out. 

In your shoes, I'd do the following:
1) Max out the traditional 401k.
2) Find out if your employer offers an HSA, and max that out (or at least heavily contribute to it)
3) Set up a backdoor Roth. (most people can)
4) Look into whether you can set up a mega backdoor Roth (this depends on your employer's 401k setup)
5) Invest the rest in taxable accounts.  Speaking of which, Wealthfront charges 0.25%. I don't know what other options you have, but you can get 0% fees over at Vanguard...

any way to max your 401k this year?

@zolotiyeruki @mistymoney I was able to allocate my last paycheck entirely towards my 401K, and I'm close to the max for 2020.

#3 #4 - (mega)backdoor roth this is gold! Unfortunately I don't think I can do this with the new employer. I'll check!

#5 - Will look into getting a Vanguard account asap. Based on everyone's responses, it sounds like I should be (a) maximizing my pre-tax contributions, (b) maxing out roth contributions if it's an option, and finally (c) putting the rest in taxable accounts, and keep an eye on management fees.

[MDM]

Based on everyone's responses, it sounds like I should be (a) maximizing my pre-tax contributions, (b) maxing out roth contributions if it's an option, and finally (c) putting the rest in taxable accounts, and keep an eye on management fees.

That's a very good summary - good luck!