Handling financial windfall calls for an expert's advice

I am in a position to make a major financial decision and I'm not sure what to do. In about 30 days, I will receive a settlement from a lawsuit sufficient to pay off our mortgage, which is currently at 6.75 percent, with about $5,000 left over. My inclination is to pay off the mortgage and invest the remainder in a tax-free annuity, which would provide tax-free income during retirement. Then my husband and I could start saving more aggressively for retirement. I have $25,000 in a 401(k) and $15,000 in a traditional IRA. My husband has about $47,000 in his pension. I am in my early 40s and he is in his late 30s. We have no debt except for my husband's student loan, which is a little less than $15,000, but he recently has started a new job at a lower wage and we barely make all of our payments every month.

My attorney and his staff are discouraging me from paying off the mortgage with the settlement and instead think I should put all of it into the annuity. They tell me that the mortgage is worth keeping because of the tax deduction.


What do you think?

Your lawyer may have a great legal mind, but he is almost certainly not an experienced financial planner. And if he's the one who told you that annuities could offer tax-free income in retirement, he's sadly misinformed as well.


One of the disadvantages of annuities is that their earnings, when withdrawn, are taxable at regular income tax rates. Withdraw the money too soon and it also could be subject to penalties and surrender charges.

That doesn't mean an annuity is necessarily the wrong choice. But you shouldn't consider one until you've exhausted your tax-advantaged retirement savings options, including contributing the maximum to 401(k)s and Roth IRAs.

Your best bet is to make an appointment with an independent financial planner for an objective overview of your situation. The National Association of Personal Financial Advisors at (888) FEE-ONLY can provide a referral.

A tax deduction shouldn't be the only reason to keep a mortgage, but you may find that there are better uses for your windfall. A planner probably would tell you to pay off the student loan before considering paying anything extra on your mortgage. You also should have at least three months' expenses, and preferably six, saved in a liquid account such as a money market for emergencies. If you decide against a mortgage payoff, the planner can review your budget to see whether there are other ways to give you more breathing room each month.

You recently answered a question from a single mother who asked how she could create an emergency fund when she earned only $800 a month. You told her about the earned income credit, a tax credit that can increase her take-home pay, and suggested she look for a better-paying job. I thought another suggestion would be to seek government assistance. Because she is raising two children on such a low income, the government could provide help with food and child care at least temporarily while she attends some job training (as you suggested). I was in a similar situation and used government assistance to help me get back on my feet.

Government assistance is definitely an option, although once she has a small emergency fund built up, she'll no longer be eligible for most help. Households are ineligible for food stamps, for example, if they have more than $2,000 in resources, including cash, bank accounts and other property.

For more information, she should call the food stamp office in her area, listed in most phone directories under "food stamps" or "public assistance."

Note: In last week's column, I wrote that E-Loan Inc. offers portable mortgages. In fact, that product was introduced last month by E-Trade Financial.


Liz Pulliam Weston is a contributor to The Los Angles Times, a Tribune Publishing newspaper.