How to Use a Year-End Windfall Wisely

It is not uncommon for people to receive extra income at the end of the year. Some workers receive a year-end holiday bonus or special distribution from their employer and more affluent ones may have reached the maximum taxable earnings limit for Social Security (FICA tax) deductions and/or the maximum amount that can be contributed annually to a tax-deferred TSP, 401(k), or 403(b) plan. There’s also the possibility of receiving a generous holiday cash gift.

How should a year-end cash windfall be used? Like most financial planning questions, the best answer is “it depends.” Some key factors include a person’s age, financial goals, net worth, cash flow, and amount of existing savings and investments.

Below are ten suggestions for investing a cash windfall:

• Fund an Emergency Reserve- Experts advise setting aside three to six months expenses in an accessible place such as a money market mutual fund or bank savings account. That is $6,000 to $12,000 if expenses are $2,000 per month. An emergency fund provides ready cash when “stuff happens” in life (e.g., sick children, injured pets, car repairs).
   
• Reduce Debt- Repay the outstanding balance on high-interest loans or credit cards. Start with debts that charge the highest interest. For example, many department store credit cards charge annual percentage rates of 20%+.  Paying off a 22% APR credit card is equivalent to earning a 22% investment return: guaranteed, risk-free, and tax-free.
   
• Invest for Retirement- Put your cash windfall in a Roth or traditional individual retirement account (IRA). Any amount that you invest will grow significantly after decades of compound interest. Taxpayers have until the tax filing deadline of the following year (typically April 15, unless a weekend/holiday) to fund an IRA for the previous tax year.
   
• Invest in Yourself- Economists refer to workers’ knowledge, experiences, and skill sets as “human capital” and a cash windfall can be used to maintain or improve it. Some examples include attending a professional conference, paying for course credits for a college degree program, or taking courses or training for career advancement.
   
• Invest in a Child-Add to the college fund of a child or student.  Depending on the type of investment that you make, you may be able to save on your income taxes. A financial advisor can help you decide.
   
• Remodel Your Home- If you plan to stay put for a while, consider using a cash windfall to make a small home renovation such as new carpeting, flooring, or bathroom fixtures. If you plan to move soon, use the money for cosmetic changes that will increase your home’s resale value (e.g., new doors and outdoor landscaping).
   
• Open a Mutual Fund Account- Many mutual funds allow investors to open up an account for $1,000 to $3,000 (or less) with $25 to $100 subsequent minimum deposits. By investing in a mutual fund, investors receive broad diversification of their invested cash and professional management of the mutual fund’s investment portfolio.
   
• See a Financial Advisor- Extra money can be well spent by seeing a financial advisor to get answers to your questions and direction for the future. Many financial planners charge hourly rates like lawyers do and some focus their practices exclusively on middle-income households. To save time (and, therefore, money), go prepared for an appointment with a list of question and copies of relevant documents (e.g., copy of latest tax return).
   
• Be Charitable- Some people elect to use part of a cash windfall to help others via donations to their favorite charity or educational institution. Donations sent via U.S. mail must be postmarked by Saturday, December 30, 2017 to count as an itemized deduction in 2017. Another giving option is to provide cash gifts to family members.
   
• Go on a Spending Spree- It is perfectly fine to use a cash windfall for fun things like shopping and entertainment. Some financial experts recommend carving out a specific piece of a windfall (e.g., 10%- 25%) for a spree.  A related option is upgrading a previously planned financial goal (e.g. choosing more options for a new car or vacation trip).
   
  Consider combining two or more of the ideas listed above. For example, 40% emergency fund, 40% home improvement, and 20% fun activities. It is also perfectly fine to take your time to decide what to do with a cash windfall. Simply “park” this money in a money market fund or savings account until you develop a plan.

Draw Your Financial Dreams

It is easier to save money for something specific than to save for savings sake. The “whys” for your savings are your financial dreams. To get started, draw a picture of what you are dreaming about financially. You don’t need to be an artist and you don’t need to have concrete plans at this point. Just put on paper a simple vision of what you want to accomplish.

Your financial dreams might include something that you want to buy or do. For example, maybe you want to buy a new car or take a cruise or have a comfortable retirement. If so, draw a picture of these dreams- or use short phrases to describe them. Dreams can also be anticipated feelings such as “financial independence” and “financial security.”

Having dreams alone is not sufficient to make financial progress. The next step is to make your dreams a reality. Many people have dreams but don’t follow through to achieve them. This is where financial goals come into play.

Set so-called SMART (Specific, Measurable, Achievable, Realistic, and Time-related) goals with a dollar cost and time deadline. An example is saving $10,000 to buy a new (to you) car in four years.  Once SMART goals are identified, it is easy to “do the math” and calculate the required savings to reach a goal on an annual or monthly basis.

Financial dreams are the spark for savings and financial goals are the flame. Draw your dreams and then develop SMART goals and an action plan to achieve them.

A New View of Reverse Mortgages

At the 2017, Financial Planning Association (FPA) meeting, the topic of reverse mortgages in retirement decisions came up in several presentations. The new view of reverse mortgages is that home equity can be used as a financial planning tool and not just as a last resort. Below are some of the key concepts that were presented:

• About 10,000 people today will reach age 62 for the next decade; 3,000 are still making a mortgage payment.
   
• Reverse mortgages allow people to receive funds as a lump sum, a line of credit, or monthly payments.
   
• With regard to criticism of that reverse mortgages “spend a child’s inheritance,” gradually depleting home equity via a reverse mortgage is no different than withdrawing money from retirement savings accounts.
   
• Borrowers (or their heirs) will never owe more than their home’s value.
   
• No payment is owed until the last living borrower permanently leaves the home.
   
• People have three ‘buckets” of money as potential retirement income sources: Bucket 1: income, Bucket 2: nest egg (savings and investments), and Bucket 3: home equity. Bucket 3 home equity distributions via a reverse mortgage can be used to delay using Bucket 2 withdrawals during market downturns.
   
• Some experts advise applying for a home equity line of credit at age 62 for possible use in later life.
   
• Reverse mortgage payments can help protect other assets (e.g., long-term-care and life insurance premiums).
   
• The CFPB recently issued a report that was critical of reverse mortgages as a financial planning tool. Some financial experts have questioned the methodology of this study, however. Bottom Line: there are a variety of opinions about the benefits and disadvantages of reverse mortgages for older homeowners. Potential borrowers need to examine them closely to determine if RMs are a good fit for them.

Give Yourself a Financial Check-Up

A financial check-up  is as important as an annual physical with your doctor.  Like a medical exam, a review of your finances can identify strategies to improve “financial fitness” (e.g., saving more money and diversifying investments and screen for potential problems, such as lack of a will or a high debt-to-income ratio.

Check-up Method #1 is financial quizzes.  Rutgers Cooperative Extension’s Financial Fitness Quiz consists of 20 questions about various financial practices.  Those with a low score indicate areas for improvement. Another check-up method is a net worth statement.  Net worth is assets (what you own) minus debts (what you owe). 

Assets have three categories: liquid (cash assets, such as a CD or money market mutual fund), tangible (personal property such as a house and car), and investment (examples: mutual funds and 401(k) plan).  Short-term debts are those that you expect to repay within a year (example: credit cards) and long-term debts, like a mortgage, last longer.

Another financial check-up tool is the “Wealth Test” from the book The Millionaire Next Door which assesses financial progress based on two key factors: age and pre-tax (gross) income.  Simply multiply these two figures together and divide by 10 to see what your net worth should be.  Obviously, the higher the number relative to this benchmark, the better.

The next time you’re scheduling a medical check-up, take time to assess your finances also.  For resources to analyze your finances, visit the Rutgers Cooperative Extension personal finance Web site.

Factors That Contribute to Financial Success

At the 2017, Financial Planning Association (FPA) meeting, the final general session speaker was financial author and speaker Jean Chatzky. Her topic was “What the World’s Wealthiest, Most Successful People Do Differently.” Below is a description of six key success factors that were described in this presentation:

 

• Optimism/Happiness- People who score “8” on 1 to 10 scale have greater problem-solving ability, longer lifespans, and increased success. Chatzky advised “prioritize doing things instead of acquiring things.”

• Resilience- People are not born with resilience. Chatzky advised attendees to “Control the things that you can control” and “take action when you feel stuck.”
   
• Connectedness- Chatzky advised attendees to build their “social capital” by sharing information, resources, and contacts. In addition, strong relationships need to be built in person and not just online.
   
• Passion- People with passion view work as a calling, “want things more,” and work hard to achieve them.
   
• Good Financial Habits- An example is habitual savings. Automatic savings deposits make it easier to delay gratification and save for your “future self” 20 to 50 years from now. Our future selves are strangers.
   
• Gratitude- Grateful people five back to individuals, organizations, and communities. They are also less likely to be affected by depression. The antidote to materialism is charity inspired by gratitude.