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<font face="helvetica, verdana, arial" size="-1">By: <b>Eva Rosenberg</b></font>
</td>
<td>
<font face="helvetica, verdana, arial" size="+2">Coping with Gain: Handling A Financial Windfall
</font>
<br><br>
<font face="helvetica, verdana, arial" size="+1">I'll bet that if someone gave you $100,000, the first thing you would do is
pay off all your debts. Then you would either buy a house or reduce your
mortgage.</font>
<font face="helvetica, verdana, arial" size="-1">
<br><br>
<b>Impulse Spending</b>
<br>
Let's explore these first impulses strictly from a tax viewpoint and not your debt-comfort level.<br><br>
<b>Paying off all your bills:</b><ul>
<li>a) If you have outstanding debt on credit cards at 18% or so,
pay them off!
Unless the credit card debts are for business, you get no tax benefit from
paying these outrageous interest rates. But, if you are lucky enough to
have a fixed rate card for under 10%, then read on!
<br><br>
<li>b) If you have a car loan at under 10%, I'd read Ken Kurson's
<a href="../../../../www_subdomain/money/columns/kurson/970324.html">companion
article</a> about how to invest and earn much more than 10% — and I wouldn't
pay off the car loan. (Remember, unless you're self-employed, you cannot
deduct the interest, even if you use your car 100% for your job.)
<br><br>
<li>c) If your mortgage is at 8% to 10%, see my comments in (b)
above. In addition to paying low interest, you can fully deduct the
interest you pay. That's still a viable tax benefit.
<br><br></ul>
For our purposes, let's say that you used $10,000 to pay off bills. That
leaves us with $90,000.
<br><br>
</font>
<font face="helvetica, verdana, arial" size="+2">
<b>No More Rent</b></font>
<br>
</td></tr><tr><td valign="top" width="160">
<font face="helvetica, verdana, arial" size="+2" color="006600">
<b> If you don't already own a home -- buy one.</b>
</td><td valign="top"><font face="helvetica, verdana, arial" size="-1">
If you don't already own a home — buy one. No
matter where you are in the US, $90,000 or $100,000 will go a long way
toward buying a house. In some areas, it will even pay for it in full.
<br><br>
Let's say you use all the money to buy a house and have no mortgage, you
will have no tax benefits (no interest deduction). However, you will also
not have rent or mortgage payments — all you'll have to cover will be
property taxes and insurance. So, while you have no interest to deduct, you
can save the difference between your old rent/mortgage and your monthly
tax/insurance budget. Most likely, that's about $6,000 or more per year
that you can invest.
<br><br>
On the other hand, if $90,000 is not enough to buy the house of your
dreams, use a portion of it for the down payment — preferably not more than
a 20% down payment (With a $250,000 purchase price, that would still leave
about $40,000 in your pocket for other financial strategies.)
<br><br>
We still have money left over. Now what?</font>
<br><br><font face="helvetica, verdana, arial" size="+2">
<b>IRA Tirades</b></font>
<font face="helvetica, verdana, arial" size="-1">
<br>
If you've got a job, invest as much as you can into the company's 401k or
other pension plan. Generally, you may put as much as $9,500 ($6,000 into a
SIMPLE: Savings Incentive Match Plans for Employees) taken from your paycheck before taxes. This means it really only
costs you about $6,800 to put away $9,500.
<br><br>
If your employer does not have a retirement plan, you'll have to set up
your own IRA (if you're married, set up two) and put away $2,000 a year ($4,000 for
couples).
As an employee without retirement coverage, you have three kinds of IRAs
to choose from — they all have the same $2,000 limits —<b> and you may only
select one:</b>
<br><ul>
<li>a) Regular, deductible IRA (tax savings in 28% bracket of $560 or
$1,120
for a couple).
<br><br>
<li>b) Regular, non-deductible IRA — no tax savings for the
contribution, but
earnings grow tax free.<br><br>
<li>c) Newer, more fabulous "Roth IRA," effective 1/1/98. You put
away
$2,000 per person after tax, hold the investment for at least five years,
then pay no tax on the earnings — as long as you spend the money on your
first home purchase or leave it until you turn 59.
<br></ul>
Oh yes, there's one more IRA: the college IRA. It lets you put a whopping $500 per
year away toward the future education of a child (doesn't have to be your
child...). But this one is complicated. The earnings are not taxable if the
entire amount is used for allowed educational expenses. However, if the
designated child goes to a cheap school — or decides to get a car instead,
some or all of the interest could become taxable. There are some tricks to
this, and we'll have a few years to figure them out.
<br><br>
And there's still more money to deal with. Bet you didn't realize $100,000 was
so much money!
<br><br></font><font face="helvetica, verdana, arial" size="+2">
<b>Boundless Municipal Bonds</b></font>
<font face="helvetica, verdana, arial" size="-1">
<br>
Many people jump right into tax-free municipal bonds so they never have to
worry about paying taxes on their earnings. This is great — if you're
80 and frail. If you happen to be hale and hearty, take a risk — try
practically anything else. Although the income from these bonds isn't
taxable (up to about $100,000), the
typical rate of return is about 6% to 6.5% if you're lucky. After tax
savings in a 28% bracket, it amounts to no more than 9% return. You can do
better than 15% in many mutual funds.
<br><br>
In fact, if you find a fund manager who doesn't churn the fund, your money
will grow mostly tax-free until you redeem your shares. Why? Whenever the
fund sells off any of its stock at a profit, you, the investor, pay
capital gains taxes on those profits. On the other hand, a fund with a low
turnover rate can have the same growth rate as one that churns the assets
but costs you substantially less in taxes. The low turnover fund gets its
growth by buying stocks in companies that are strong and growing. These
managers hold the stocks for the long term. Therefore, the fund value
increases as the values of the stocks increase — without having to sell the
stocks to achieve the same results. Most publications like Worth, Money,
Kiplinger's, etc. list the funds and show the turnover rates.
<br><br>
In fact, there was a US News and World Report article on June 9, 1997, that
listed the top three picks of ten successful fund managers. Of the 29 funds
(one was selected by two managers), ten of them had turnover rates of 25% or
less. (This means that they did not sell about 3/4 of their portfolio every
year.) Looking at the nine low turnover funds that had been around for five
years, their average annual rate of return (over five years) was over 27%.
Some of them substantially higher than 27%!
<br><br>
Considering a 28% tax rate, you still have over 20% return after taxes.
This certainly beats the 6.5% tax-free returns. But most of this will be
capital gains, so the after-tax returns will be even higher — and much
deferred. The only thing you pay taxes on while you hold the funds are
your share of the dividends, which you should leave to be reinvested and grow.
Let's be truthful, though. These returns are based on a booming market. If
you prefer security, go for the bonds.
<br><br>
Any other tax-advantaged things you can do with your money?
<br><br></font>
<font face="helvetica, verdana, arial" size="+2">
<b>Annuities</b></font><font face="helvetica, verdana, arial" size="-1">
<br>
Take the whole batch of leftover money ( about $30,000 at this point) and
buy yourself an annuity. It will grow tax-free at about 7% to 9%. Some of
them may let you borrow against it after seven years or so. Some annuities will
also let you chose to invest part of the money within the annuity in
stock-based assets. These add marginally to the risk, because most of these
annuities seem to provide a minimum guaranteed rate of return.
<br><br>
Personally, being self-employed, I'd look at a non-tax-advantaged
investment: a disability policy that would replace at least 75% of my
income. While you get no tax benefits for the premiums you pay, you get
real benefits if you are ever unable to work. <b>And</b> the disability income you
receive is not taxable because you paid for the premiums. (The premiums are
not deductible as medical or business expenses.)
<br><br>
There are a few more options, but your eyes are probably glazing
over by now.
<br><br>
What would I do with a free $100,000? Heck, I'd pay off all my bills,
except the mortgage. Then I'd spread the rest among several of those 9
low-turnover funds. Some of the money I'd free up from bill-paying would go
into my retirement accounts, which would also be invested in those funds.
<br><br>
The rest of the money? Well, I'd go play, of course. Wouldn't you?
<br><br>
Sites to play with:
<br><br>
<blockquote>
Money.com
<br>
Worth Magazine
<br>
Kiplinger Online
<br>
Kiplinger Online's Financial Calculators
<br>
U.S. News and World Report Online
</blockquote></font>
<hr width="150">
Eva Rosenberg, MBA is an Enrolled Agent in Encino, California. She is a
sought-after speaker on tax and small business issues. Her practice focuses
on small business, non-filers and problem tax audits. Please submit
questions for this column to <a href="mailto:giftsurf@mywishlist.com">giftsurf@mywishlist.com</a>. Look for
replies to
be posted at <a href="/">http://members.tripod.com/~EvaR/TaxBytes.html</a>
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