What to do with that crock of gold?
Kevin Connolly
25 September 2007
What would you do if you suddenly came in to a hefty cash sum of money? Selling that fraction of the farm as a site or for road building, getting notice of that maturing life assurance policy you forgot you ever had or receiving the inheritance from a much-missed relation who has passed away and wanted to ‘see you right’. The truth is that while not many of us would refuse a large cash windfall, for some, having more money than you know what to do with can be daunting. It can even be stressful for people who see this as a key to financial freedom provided they make the right decisions and don’t squander it.
If you’re lucky enough to have received such a windfall here’s some general advice on making the most of your newfound wealth.
Play it cool
The worst thing is to rush in and spend or invest in the first idea that presents itself. Blowing the lot on a whim or locking it all away in some long term, high penalty, low return investment is often the result of the ‘fools rush in’ syndrome. Take the time to weigh up all the options- read the personal finance pages of the national newspapers and tap as many people as possible for useful information. Extract as much information as you can from as many sources such as friends, fellow farmers, advisers, bank managers, accountants but don’t commit to anything until you feel you understand fully what it is you are getting into.
Take stock
Before you consider becoming the latest Warren Buffet (the famous stock-market investor) you should first throw your eye over your personal and business finances and see whether there is any scope to tidy these up.
The key area here is to examine your personal and business debt. Personal debt, such as car loans, house mortgage, credit card loans all must be paid out of after-tax cash i.e. there is no tax write off available on the interest on these loans. For this reason they should be the first to get the chop. If you can list each loan together with its outstanding balance and its interest rate it will make it easier to identify which loans to target. A lot of personal loans are subject to high rates of interest and by paying these off you are in effect getting a return equal to the interest rate.
| Example |
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| Take an average monthly credit card balance of €1,000 over a one year period which is subject to an interest rate of 16% (not that uncommon – have you checked yours lately?). By years end you will have paid €160 in interest (not to mention other surcharges often imposed). Paying off the debt in full saves you the €160 in interest which is essentially a 16% return. Not too many investments can match that type of return. |
For farm business loans you need to look at the after-tax cost of the debt and weigh that up against your best expected return from investing the money elsewhere instead of using it to clear the debt. The after-tax rate is important here since for farm business loans the interest is allowable as an expense when calculating taxable income.
The questions you need to answer when looking at clearing loans are:
- What rate of return will I get by paying off the loan?
- Is there any other investment out there that will better this return rate?
An example is the best way to examine how this works.
| Example | |||
|---|---|---|---|
| Farm Output | €80,000 | ||
| Farm Expenses | €70,000 | ||
| Farm Profit | €10,000 | ||
| Assume a loan of €1,000 at a rate of 10% - Total interest payable €100 | |||
| If loan left as is: | If loan cleared: | ||
| Farm Profit | €10,000 | Farm Profit | €10,000 |
| Less Interest | €100 | Less Interest | |
| Taxable Profit | €9,900 | Taxable Profit | €10,000 |
| Tax @ high rate – 46% | €4,554 | Tax @ high rate – 46% | €4,600 |
| Total interest & tax paid | = €4,554 + €100 = €4,654 |
Total interest & tax paid | = €4,600 |
| Saving from clearing the €1,000 loan | = €4,654 - €4,600 | = €54 | |
| Investing the €1,000 instead of repaying the loan would have to provide a return of greater than €54 (5.4%) to better the option of repaying the loan. | |||
| This break-even return can be calculated using the after-tax loan rate | = Loan rate X (100 - Tax Rate) / 100 | ||
| Tax @ high rate – 46% | = [10 X (100 - 46)] / 100 | = [10 X 54]/100 = 5.4% |
|
| Tax @ low rate – 25% | = [10 X (100 - 25)] / 100 | = [10 X 75]/100 = 7.5% |
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Looking at the return achieved from eliminating interest payments is one thing but for some the thrill of clearing loans and being ‘debt-free’ gives peace-of-mind and a sense of achievement which is better than any monetary return.
Create an emergency fund
A mistake often made where a windfall sum of money is spent or invested too quickly is where provision is not made for future potential short term requirements for cash. Locking money away in a long term investment fund (with penalties for early withdrawal) or burying money in illiquid assets (property, land, farm assets) is often the route taken with ill-advised haste. But it makes no sense not to ensure you have a small pot of money aside for short term requirements. This could be looked on as an emergency fund, for those unforeseen demands for cash in a hurry or for planned short term requirements such as deposits for houses, education costs etc. Having such a fund in place will at least mean you won’t have to borrow the money at potentially high interest rates while your windfall cash is locked away somewhere where you can’t easily get your hands on it and is earning a lower return than the interest rate on your new borrowing.
Make a will
Having a will made to set out how you want your assets to be divided up on death is good advice at the best of times. It is especially good advice if you have a source of new-found wealth and a lot of people are suddenly taking a lot of interest in you and your health! By putting a will in place you ensure that your assets and estate will pass to your desired beneficiaries with minimum bad-feeling among those you leave behind. You may also be able to minimise the amount of tax due on the transfer of your assets when your inevitable death occurs.
Plan for your own future
It may also be a good time to check up on how that pension you’ve been paying into for the last few years has been performing. Dropping a lump sum into your pension to maximise the tax reliefs available is a very wise thing to do as part of an overall investment plan. The extra tax relief gained may allow you to claim tax back for a previous year which is an added bonus (See the ‘Put your profits in a pension’ article in the September/ October issue). The money in the pension will accumulate in the fund, tax free and will allow you to have a structured steady income at retirement age in addition to any other investment income you may have.
Looking to invest?
Finally you will be left with a pot of money that you would like to invest in the hope that it will generate some level of return for you. If you want to make the most of your investment then it is important to have clear idea of what your expectations are.
| Some questions you should have answers for include: |
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You will have many options when it comes to investing your windfall with the most obvious one close to home, that is, in the farm business. It always makes good sense for people or businesses to invest in what they know best but there should be sound reasons for doing this. Achieving a good financial return is one reason and for a lot of farm based investment the returns achievable are not always clear-cut and even if clear are often not very favourable. However even investments that look financially weak are often justified for family and lifestyle reasons. A good acid-test to help you focus on the relative importance of business investments is – if I had to borrow the money would I still make the investment?
Diversification
The old saying ‘Don’t put all your eggs in one basket’ is a wise one and your financial windfall may give you the opportunity to look beyond your traditional safe options for spare cash. By spreading your invested funds over a number of different types of investment class (property, shares, bonds, cash deposits) you are reducing the risk that a financial shock to one asset is going to have a potentially crippling effect on your overall wealth.
Having financial interests in assets other than farming assets is seen by some as a good way to ensure that the thorny issue of succession is made less painful. With non-farming interests in place the older generation may feel more comfortable in transferring over the farming business to their successor if they know that these non-farm investments are there to provide some security and perhaps an income in retirement. It may also facilitate the provision of an alternative inheritance to those non-farming members without having to go down the route of forced selling of farming assets or imposing monetary settlements on the recipients of the farm.
Going outside your traditional homes for cash will require some research on your behalf. Diversification should reduce your risk but only if you make sound choices which are based on solid information and not false promises or hearsay. Not jumping at the first ‘once-in-a-lifetime’ opportunity that comes along is key here. If you don’t have the time, the know-how or the contacts to do this research then it may be money well spent to use the services of a professional financial adviser to do it for you.
After all investing in good advice often provides the best return of all.
For large sums of money the wisest course of action may be to pay for fixed-fee advice from an Authorised Adviser (AA). A list of such advisers in your area can be obtained by contacting the Financial Regulator on lo-call 1890-200-469 or by email registers@financialregulator.ie