How to Handle a R1m Windfall at 22 yo?

[dyvinka]

My (26M) cousin (22M) was awarded a settlement of just over R1m in cash (post-tax). I thought it prudent to check our ignorance here before he commits to anything, although I have advised him to consult a CFP® (please recommend one) and tax adviser/practitioner.

BACKGROUND

He is currently a 2nd year student at a private college (BCom Marketing). He lives at home with his parents covering all his typical living expenses and tuition. He does battle with mental illness (e.g. clinical depression; ADHD and the like) and has been seeing a psychiatrist (although, not quite as often as needed due to financial constraints). He’s yet to have regular sessions with a psychologist (again due to finances). He spends most of his days in his bed and struggles to go about his daily tasks. He doesn’t drink or smoke.

He doesn't have a monthly allowance or income. I have pushed back against his mother and aunt suggesting he purchase a vehicle because he would need to use even more of the principle from the windfall to fuel, maintain, service and insure the vehicle. He also only has a learner's licence so insurance is likely to be high for newly a licensed driver.

While I realise the time value of money and inflation is a key aspect; I've elected to ignore that maths for now. This is to say, I suggested he invest for income over the next 3-5 years until he completes his honours and begins working full-time (I hope it allows him to learn the basics of finance (like saving), with a smaller amount). I would also like him to have money to refill his prescriptions, consult his psychiatrist as and when needed and begin therapy. He could also get his driver’s licence. These would hopefully make a meaningful difference to his daily life and assist him in his studies.

BRAINSTORMING

The finance minister did not adjust the tax brackets so the primary rebate places his tax threshold at R95 750. Additionally, he has the s10(1)(i) interest exemption of R23 800. This means his effective tax threshold is R119 550. So, here's a napkin plan:

1. He opens a TFSA now and makes his R36 000 contribution as a lump-sum. He’ll purchase an ETF and wait for subsequent periods to do the same. We’ve considered 10X Total World Stock Tracker Feeder ETF; Sygnia MSCI World Stock ETF and Sygnia S&P 500 ETF. We are still reading more about these to figure out what makes sense; and
2. He keeps R60 000 in the savings account linked to his FNB account to serve as a small emergency fund. He will allow whatever interest earned on these funds to compound; and
3. He allocates R220 000 to a 5-year RSA Retail Savings Bond at 10,75% for R23 650 pa (or R1 970,83 pm). The annual interest is below the annual exemption so even if he starts working within the next 5 years these proceeds should always be tax-free. Access restrictions also mean I shouldn’t be seeing my boii on “I Blew It” for at least 5 years lol; and
4. He allocates R300 000 in a Money Market Account at Standard Bank (he already banks there). The quoted rate is currently 8,70% for an annual return of R26 100 (or R2 175 pm). He use R36 000 from this account next year to allocate to the TFSA; and

In addition to the above, he can then decide on one of the following:

1. He allocates another R300 000 to a Standard Bank Flexi Advantage Account (12 months fixed deposit). The quoted rate is currently 8,51% for an annual return of R 25 530 (or R 2 127,50 pm). He can access upto 40% without penalty during the investment term. I figure 12 months so he can make new choices a year from now as he learns more and context of his life may change; or
2. Recognising that the MoneyMarket in point 4 is quite liquid already: instead of no. 5 he rather allocates R150 000 into a 2-year RSA Retails Savings Bond at 9,25% and another R150 000 into a 3-year RSA Retail Savings Bond at 9,75%. This translates to R14 625 pa (or R1 218,75pm) and R13 875pa (or R1 156.25pm) respectively. He can fund his TFSA with a portion of the capital when these mature.

The above accounts for R916 000.00 allocated. I’ve read that one should allow themselves to indulge with anything from 2-5% of the windfall; I have nothing to say on it but it seems reasonable. If he chooses option 5 above then that brings him to R79 900 pa (or R6 658,33pm) and if he chooses option 6 then it comes to R82 870,00 pa (or R6 905,83pm). They’re both below the tax threshold so no need to worry about SARS and each come to a weighted average return above 9%. Hopefully, it’s enough for him to have regular therapy; get into the habit of regularly saving and investing; get his driver’s licence; refill prescriptions; buy clothing; pick up his hobbies again and perhaps partake in a few things that bring him joy like an outing with friends.

I realise inflation eats away at his principle over time as he’s not re-investing the interest (aside from TFSA contributions). I figure ≈R900k in 3-5 years’ time is still a great sum of money for a person in their 20s, just starting out in their working career. Hopefully, he’s more comfortable with finance when those years roll in. He’ll make the max contributions to his TFSA every-year until then and move away from this income focused strategy when he has a salary.

Does he need a will; if so is it typically a one-off cost or monthly cost?

 

[alexbavib]

@dyvinka Bud,

This is a well researched post and I think your cousin is lucky to have you.

If he does even half of what you’re recommending he’ll be better off than the majority of people.

 

[iamtanner]

@dyvinka Wow. Wish I had someone like this in my life

This is great research and is compiled wonderfully

 

[faith4l]

@dyvinka Ultimately you need to invest/save based on goals. Both short, medium and long term.

If there is no goals just yet, don't rush it and park it. So based on " suggested he invest for income over the next 3-5 years until he completes his honours and begins working full-time" I agree completely. Don't rush into investing it all long term when short term needs potentially is not covered yet. Considering that he is young, I would be careful to allocate too much to long term investment vehicles unless the short term is covered. But you seem to be on the same conclusion here - but also don't ignore long term from the get go, think of it all, but let the investments/savings complement the goals, not for the sake of it. Same with picking funds - let it be done to complement your goal/strategy/portfolio etc.

I think you need to

• Get an actual budget of what he will need to cover monthly and bigger expenses like tuition. So figures to work with here are important.
• Since he doesn't have dependents or much responsibilities yet, emergency savings can perhaps be less. Since his income will be based off investments, he has less risk in this aspect. But given that big portions are potentially allocated to liquid investments already, you can consider to ignore emergency savings. But 60k is not enough to stress over. If provides comfort and peace of mind to having separate allocation, go for it.
• TFSA early on can be a wonder for retirement years. No need to speculate or invest in overlapping funds. 10X Total World to start out with is basically as good as it gets in terms of the average market portfolio without the need for tinkering. Going against the market you need to be highly convicted and hopefully have evidence to support your decision. Starting out, keep it simple and fundamental. Maxing it for 3 years is about 10% allocation of the windfall which is not something that should be to concerning. 5 years if the plan allows for it, why not.
• Financial literacy - Get him a book or 3. At the end of the day you won't be able to always manage or assist in managing his money. He needs to slowly learn and be able to make educated decisions.

In terms of financially allocating

• Income: Since the withdrawal period you are looking at is 3-5 years, I would probably look at something like 0/100 - 25/75 percent allocation to equity/income, depending on what you are comfortable with. Example here can be NightyOne Diversified Income / Sygnia Enhanced Income coupled with 10X Total World. Alternatively simple access like money market can work as well if you want to keep it more simple. Ideally this is something you are going to drawdown on and deplete in 3-5 years and reassess needs with rest of funding. So not over allocating.
• TFSA Funding: As above but income focused only. Can even do 12/24/36 month Fixed Deposits or Bonds if you want it locked. But be careful for over complicating it.
• Emergency: If needed, needs to be liquid or some short time frame. Hundreds of posts on this but touched on sort of already.
• The rest: Now if you want to restrict his access, I can understand the reasoning for bonds. Since time frame is not known, 3 and 5 year split. But ideally here, the rest, should not be used to draw income from or interest. Ideally this should be reinvested to keep up with inflation and potentially be used for say a car in 5 years or a house deposit in 8 years. I would probably invest this in some 25/75 allocation and let it sit for 3-5 years until next goals are clear. He is going to need a place at some point. He is going to need a car at some point.
• Indulge: For sure, if he's needs like prescription and appointments are covered, let him have some fund and do what he wants. This will mentally help him as well to actually feel some of the money instead of it all just going locked away

I highly suggest you review this site for alternatives to banking accounts and fixed deposits. I didn't do the math on interest exemption as figures need to be more clear in terms of budget and other short term financial responsibilities.

 

[faith4l]

To add, for a will, there is more than one option.

Some companies/insurance houses charge monthly and others do it for free but will use their own executor in order to get the ~3% fee (or whatever the rate is these days).

Often its better to draft through a say a lawyer and appoint your own executor instead of paying for something upfront and monthly ongoing. But there is different setups. Filter by estate and you should get some past posts.

Ultimately, its not bad to have a will, even a basic one.

 

[dyvinka]

@faith4l Thank you for taking the time to write back. Your response gave us many things to consider especially the tunnel vision towards the short-term only. Another thing that we found valuable as you mentioned is to draw up his budget (including costs covered by his parents) so he can get used to how to do it and not have the rug pulled later. I believe the full budget also allows him to understand how much things cost too. I'm sure you can appreciate how overwhelming the situation is as you're literally learning to swim while drowning.

As a long-term plan we're quite set on the TFSA as he cannot get the time back if he misses years. He would rather reach his lifetime limit sooner. However, he's uncertain about his medium to long-term goals although one expects that will clear-up in therapy and dealing with life outside of formal education.

I have looked at a few recommended books by Bogleheads. I will be sure to pass-on the list. We learned a lot from your response and will take things slow as he learns and becomes more comfortable with the concepts and how to do things as it is his first-time budgeting, saving, investing etc. and it's all a bit disorienting when happening all at once. I'm trying not to act as an advisor or control him but just offer guidance and help researching. It's ultimately his decision(s) and responsibility.

Thanks again.

 

[prarierose91]

@dyvinka If it were me, I'd invest his needs for the next 3-5 years in a money market fund and put the rest in world markets through easy equities. 10x total world, for example.

 

[dyvinka]

@prarierose91 Hello.

Yes that is a compelling. He is still beginning with financial literacy and how to budget, save, invest etc. for the first-time. He's finding it overwhelming with all the financial terms and jargon and I can see the anxiety it's causing. He's not quite comfortable with what's what so he'll be taking it slow for now but hopefully he gets to a place where he's as confident and comfortable as you to execute a long-term strategy.

If I may ask, is there a physical office for Easy Equities or 10X in Gauteng where we can speak to someone in-person? I know this is an odd question but our family isn't about emailing/calling when we have trouble with a company. We'd rather walk into a bank branch (for example) and deal with someone here and now but walk out satisfied with the outcome.

 

[autisticchristianknight]

@dyvinka Seems like a good plan. But I'd also recommend you let him spend a couple thousand of the money. Just make sure he that he asks you every time he's about to make a purchase (otherwise he'll end up wasting his money on an overpriced iPhone).

I also 100% agree against buying a car. If he lives with his parents, he can just borrow one of their cars. That's pretty much what I do and it works perfectly fine

 

[dyvinka]

@autisticchristianknight

But I'd also recommend you let him spend a couple thousand of the money. Just make sure he that he asks you every time he's about to make a purchase

I can't allow or prohibit him from making certain decisions with his money. I'm not trying to control him or become his financial advisor. He's a grown-up after all. I would just like to guide him in the right direction but reckless spending is indeed a concern. Hopefully we can slow things down a bit so he's got time to set his head straight.

If he lives with his parents, he can just borrow one of their cars.

Correct. His parents own 4 cars so technically there is always one available in the house, if they'll allow him.

 

[patriciusv]

@dyvinka Set aside 100k into a high yield account and convert the rest to USD and invest with IBKR into VOO, buying weekly for 5 weeks in equal amounts to average in then forget about it for 30 years

 

[dyvinka]

@patriciusv Hi. I'd need to read up on this more as I'm not learned on tax outside the Republic. I'm hesitant to become his de facto 'financial advisor.' I've seen this mentioned in this sub so I'll go through those posts to find my bearings about it. He'd also need to figure out the tax effects of the potential forex gains/losses.

I would like to encourage him to continue to diligently add to his investments over the years. I don't anticipate his salary for the first couple years will be enough for him to regularly convert to USD and send money offshore with the forex spread and fees. Is there a local equivalent to the Vanguard ETFs?

 

[sdb]

@patriciusv this is the best advice on this thread. I’d go for CSPX or SWRD and not VOO, because VOO is domiciled in the US and will cause estate tax issues later on.

 

[dyvinka]

@sdb Thank you @sdb. We will definitely do some reading on these as well.

 

[peggys]

@dyvinka Way too many interest bearing investments. Put it in the S&P and double it in 5 - 7 years.

 

[karuna167]

@dyvinka I wish I had, a) parents who had given me sound financial advice and b) paid attention in EMS.

 

[rachelc0]

@dyvinka That is a very detailed post, I'm sorry I don't have the time to post a detailed response. But just an observation from my side, you will get taxed on the interest because they're coming from almost 3 different sources from what I can see. Those accounts at standard bank earn interest so you will exceed the annual exemption

 

[jermaineman]

@rachelc0 he's still in the 0% income tax bracket since he has no other income. So OP rightly pointed out that he can earn almost 120k interest income per year tax free.

 

[zvikisum]

@dyvinka You seem to have alot in cash. He is still pretty young, rather put more in foreign stocks. Also open up a retirement annuity as there is a tax benefit. Looks at a company that does not use brokers(Sygnia, easy equities, 10x)

 

[dyvinka]

@zvikisum Yes, many others have mentioned that this is cash-heavy (or almost exclusively). We've come to the conclusion that we should rather assess the real need for cash with a budget then go from there to allocate the rest to other avenues for better balance between short-, medium-, and long-term.

The s11F tax benefit for the RA wouldn't come into play for a while as he still falls below the tax threshold until he comes by full-time employment when he completes his studies. We have looked towards maxing the TFSA contributions every year though and beginning to get ETFs through that vehicle.

Please explain more about the companies that do not use brokers (admittedly idk who is who in the zoo as far as all the FSPs go). What's the advantage there? What are the signs that I'm not dealing with the broker?