Tax returns, bonuses, redundancies: How to manage a lump sum?

Bryce: [00:00:28] Welcome to another episode of Get Started Investing, a podcast where we aim to answer all of the most common money and investing questions that come from our community. Now, if you have joined us for the very first time, welcome, we do strongly recommend that you scroll up and start at episode one. Now, while we are licensed, we're not aware of your financial circumstances, so any information on this show is for entertainment and education purposes. Any advice is general? But with that said, let's crack on. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you? 

Alec: [00:00:55] I'm very good, Bryce. Very excited for this episode. 

Bryce: [00:00:58] That's good. 

Alec: [00:01:00] Now we're answering the question, What do you do when you get a windfall? 

Bryce: [00:01:04] A windfall? Yes. Yes. 

Alec: [00:01:06] That term windfall has been hotly debated in the equity mates office. Here is what we're talking about here. A windfall. You know, we're talking about when you get a lump sum of money.

Bryce: [00:01:16] Extra money.

Alec: [00:01:17] When you get a bonus from your job, maybe an inheritance. For some people, sadly, with job cuts, there might be a redundancy. Maybe you win the lottery. It's really just any large sum of unexpected money. Yeah. And there was a debate about whether all of those are a windfall or whether a windfall has a positive connotation. Like, I don't think you should say I got a windfall. I got made redundant. Yeah, but, Alf in the office out Googled us and saw everything's a windfall. 

Bryce: [00:01:50] So specifically, we. This was triggered by a question from Siddharth, and he said, What should I do with the extra income I have coming in ad hoc, i.e. from overtime? He's got a 4K tax return coming in. He wants to know if he should be paying down. Hex is at the age of 27. And is just thinking through. You know, as you said, that windfall or those large lump sums. A good example is your tax return coming in. What's the best way to approach those ad hoc lump sums of money that realistically don't appear in your budget? You don't budget for? Well, not I certainly don't budget for the tax return that comes around every year in those sorts of things. So that's what we're going to answer today. 

Alec: [00:02:29] Yeah. So I think there's a few key rules of thumb that we're going to go through to help you think about it and then a few other considerations at the end. I think where we've got to start is to be aware of tax because nothing can ruin a windfall faster than blowing it all and then getting a tax bill. 

Bryce: [00:02:51] Yes. Well, what do you mean by that? Blowing it all and then getting it. 

Alec: [00:02:54] Well, I mean, you know, you get ten grand paid to you. You spend all ten of it, and then the tax office says you owe us three of that. Yes. Yeah. You've got to find some money somewhere. Yeah. So I think the first rule of thumb is if you get money, be it an inheritance or a redundancy or a bonus from work, how much of that is going to leave you in tax? 

Bryce: [00:03:18] Yeah. 

Alec: [00:03:19] So we don't give specific tax advice here. But generally, here's how some of the different potential windfalls are treated. 

Bryce: [00:03:28] Yes. 

Alec: [00:03:29] So let's start with the tax return, because I think that's probably the most common lump sum that most people get. Yeah. No tax. No tax. No tax on tax. 

Bryce: [00:03:37] Yes, that's the beauty of it. So tiny attacks in the tax office says, hey, we actually. Are you a bit of money? Yeah. And here it is. 

Alec: [00:03:44] So blow it. So no, another one. Inheritance. Now, Australia doesn't have an inheritance tax, but that doesn't mean there won't be other taxes levied as ownership of an asset passes from someone to you. Yeah. So, you know, there are intricacies there that you need to figure out. But if it's just cash, we don't tax inheritances. 

Bryce: [00:04:12] Yeah. Figure it out from your tax accountant. Know what the intricacies are? Because there's some serious ones. Redundancy, Ren, so redundancy payments from your employer, they receive the concessional tax treatment depending on your income and other factors, which I. 

Alec: [00:04:26] Was surprised by. I would have just assumed that a redundancy payout gets just factored into your assessable income. According to the ATO website, your genuine redundancy payment and I think that's an important test. This is a genuine redundancy. It could be tax free up to a limit depending on how many years you worked. Then it will be concessional taxed as an employment termination payment above that tax free limit and then above that it will be taxed at, you know. Normal marginal rate of tax. So there will likely be some tax after that tax free limit. But it's not just treated as normal income. 

Bryce: [00:05:07] Yeah, you're not going to get hit at whatever your actual tax rate is. Yeah. All right. So that's inheritance redundancy. I've done well and it comes to bonus time and I'm lucky enough to get a bonus from my employer. How am I going to be treated in terms of tax from a work bonus? 

Alec: [00:05:25] Yeah. So bonuses form part of your assessable income, which is why financial advisers would often suggest think about if you should direct some of that to your super. And I know we're jumping ahead here, but if your bonus is going to push you up a tax bracket or, you know, like part of that bonus will be taxed at a higher rate. There's an argument that you could take advantage of putting some of that bonus into your super at the concessional tax rate. 

Bryce: [00:05:55] Yes. Not to confuse things. This happened to me at Woollies, though, where you would get the bonus and it would push you up into a way the tax man thinks you're in another tax bracket. You then do get a bit of it back at tax time when they do the sums but there is tax on your work bonus regardless of what what what. 

Alec: [00:06:15] Part of your income. 

Bryce: [00:06:16] Part of your income. 

Alec: [00:06:16] Okay. So a couple of other ways that you might get a windfall. Then let's get into how you should deal with it if you get a prize. 

Bryce: [00:06:24] Who wants to be a millionaire?

Alec: [00:06:25] Yeah, Who wants to be more willing to be a millionaire than your wife? Yes. One. Yes. Didn't quite get the mill. 

Bryce: [00:06:32] Not quite the mill did pretty well. No tax. No tax. Straight into the bank account

Alec: [00:06:37] Do you even declare it? 

Bryce: [00:06:37] No. 

Alec: [00:06:38] Nice. If it's a gift and what have you. So if it's a gift from work, you might need to. You do need to declare, I think, as part of your assessable income.

Bryce: [00:06:47] As in, like, if equity mates were to gift. 

Alec: [00:06:50] Rather than giving us a bonus. Equity mates gave us a. 

Bryce: [00:06:53] Rolex. 

Alec: [00:06:54] House. Yeah. 

Bryce: [00:06:57] Okay. Yeah. I mean, yeah, I say that that makes sense. 

Alec: [00:06:59] But if it's a gift from your family member, No tax. 

Bryce: [00:07:02] Yes, that's correct.

Alec: [00:07:03] Must be nice. 

Bryce: [00:07:04] That is correct. 

Alec: [00:07:04] And then finally, gambling winnings. If gambling is part of your job, like if you have, like, a system. I remember this from from uni days. Not that I was a professional gambler, but I learnt about how the tax treatment follows. Exciting. If you have, if you're like a professional punter and you've got a system, then it's your job and it's you declare it as income. But if you're just having a punt on the Melbourne Cup and you win. 

Bryce: [00:07:33] So What about all of those people out there that consistently match betting every weekend? 

Alec: [00:07:43] I don't know. 

Bryce: [00:07:44] Yeah. Anyway, so really what we've discovered is that rule number one, be aware of the tax because depending on the type of windfall or the type of ad hoc lump sum, there are going to be different tax treatment. 

Alec: [00:07:55] Yeah. And the reason we start there is because after we've gone through that that step, we actually know how much we have in our windfall. Yeah. Before when we just have our windfall pre-tax, we actually don't know how much we have to play with, spend or invest or blow. But now once we're aware of the tax and we know how much we need to put aside for the end of the financial year, now we can get to the good stuff.

Bryce: [00:08:17] Yes. 

Alec: [00:08:18] How are we going to spend. 

Bryce: [00:08:19] So rule number two is time is your friend. And what we mean here is you get your windfall. There can be a level of excitement around it and a level of, you know, you want to go out and and spend that money. Don't blow it. Take a deep breath, put it in a high interest savings account and wait. 

Alec: [00:08:38] And don't tell anyone. And time is your friend here? I mean, not so much if you get a work bonus. I mean, if you get a work bonus, don't tell anyone because no one gives a shit that you got a bonus. Like maybe tell your partner if you can, you know, do something with it. But no one wants to hear how much you get paid. But it's more if you win the lottery. 

Bryce: [00:08:57] Don't tell anyone. Yes. Yeah. But I think this is a good one because you'll often find that the what you want to do with it in the first week of getting that windfall, that's what you think you should do with it within the first six months is, could be completely different. 

Alec: [00:09:12] So then when it comes to actually thinking about spending it or investing it, so this is rule number three. How do you invest it? I think invest sustainably is a really important thought. And, you know, when we're preparing for this episode, well, writing online, a lot of online advice will say something like buy an investment property. But if you're going to do that, make sure you're not just putting a down payment on something that you can't afford. 

Bryce: [00:09:36] You're sitting on a massive windfall to be just like I'm buying an investment property. 

Alec: [00:09:41] Yeah, well, I mean, look, this episode is straddling the line between I got, I got $1,000 tax return and I've won $1,000,000 on the lotto. So. 

Bryce: [00:09:51] Yeah, like, I don't think I've ever got a tax return and gone. Hell, yeah, I'm going to go fight the investment property. 

Alec: [00:09:56] Yeah. Yeah. Okay. So this is more like you. 

Bryce: [00:09:59] Got a huge. 

Alec: [00:10:00] Going to Who Wants to Win a Millionaire and you win $250,000 and then you buy a $1,000,000 investment property. Three years later, you realise, oh, I actually can't afford the mortgage repayments. 

Bryce: [00:10:12] Yeah. Three months later. 

Alec: [00:10:13] Not ideal. Yeah. Yeah. So invest sustainably. A good rule of thumb, any financial windfall should help pay down debt rather than acquire new ones. 

Bryce: [00:10:24] As in don't go out and buy an investment property. 

Alec: [00:10:28] Well or just you know, anything like don't get an expensive car that you get a loan for or you know, any other type of debt use the financial windfall to. Debts rather than adding new debts. So while we're talking about debt, paying of debt is, I guess, the most sustainable way of investing. 

Bryce: [00:10:48] Yeah. Yeah. Windfall. Yeah. 

Alec: [00:10:49] Cause, like, the benefits of not having to service that debt. Yeah. Pay in cash to pay back. Yeah, yeah, yeah, yeah. Can compound over time. There. There are two methods of thinking about paying down debt. What debt to pay down first. The first one is the highest interest rates first. So if you've got a credit card that's charging in 19% interest mortgage, that's charging you 6% interest and a hex or like help university debt. That's just indexed to inflation. You would say, alright, well, the credit card is the highest interest, so I'll pay that to get.

Bryce: [00:11:20] Rid of it. 

Alec: [00:11:21] So that's one method. The second method is Dave Ramsey's snowball method. He's a financial radio host. 

Bryce: [00:11:29] Guru. 

Alec: [00:11:30] Is he? Yeah. Yeah. Over in the US. And he says, Get all your debts. Line them up from smallest to largest. Yeah. Don't worry about the interest rate, because getting your money sorted is more psychology than maths. And he says what you want to do is build momentum and you want to pay down the smallest debt first and then the second smallest and the third smallest. And then 

Bryce: [00:11:51] Feel good about it. 

Alec: [00:11:51] Feel good about it, build momentum and start crossing them off the list financially. Like, mathematically, that doesn't make as much sense. But psychologically it does. And it's really just whatever gets you. 

Bryce: [00:12:04] To the end. Yeah.

Alec: [00:12:05] So that's sort of one thing to think about. If you get a windfall pay down.

Bryce: [00:12:10] Pay down your debts, once you've done that, you can then turn to thinking about boosting your superannuation or investing outside your super with any form of of of windfall. So if you're going to boost your super. Be aware of the concessional contribution cap. I think it's 27 and a half thousand dollars a year. There are a few other, I guess, intricacies around it if you want to roll it up. 

Alec: [00:12:33] But yeah, so it's like 27 and a half thousand dollars a year on top of your normal employer contributions gets taxed at the 15% concessional. Right? And then there's a maximum cap on how much you can contribute, but that gets taxed in normal, right? Yeah. Um, I think it's like $180,000 a year or something like that. 

Bryce: [00:12:53] Yeah. So boost super or invest outside of it, but invest sustainably. I make sure it's an investment you can afford. Or if you're investing in the share market, building wealth that way, then you can think about parking money in your mortgage offset account where you get the double benefit of, I guess, an investment like return, but also you have the liquidity there should you need it. And what we mean by an investment like return is if you're saving five and a half per cent interest on your loan by having money in your offset account, that's the equivalent of investing it at five and a half percent return. 

Alec: [00:13:29] That's actually the equivalent of getting more than five and a half percent return because you pay tax on your investment. 

Bryce: [00:13:34] True. And if you don't have an offset account or you don't have a mortgage, but you still want the liquidity, good news is these days you can get savings accounts with the almost the equivalent five and a half per cent or thereabouts on your savings accounts. And then finally, we've spoken about on the show before education bonds or other tax advantaged investment options. So pretty much comes down to don't blow it. Pay down debt, build wealth.

Alec: [00:13:59] Yeah. Yeah. So that kind of like the rules of thumbs. And I think, you know, the key role is like a windfall is a one off. So don't put yourself in a worse financial position by, like, getting into more debt restructuring, you know, getting an investment loan that you then won't be able to service or getting a mortgage that you might be able to service. Let's take a quick break here. And then on the other side, let's talk about how we personally have managed any windfalls recently. Welcome back to Get started Investing. Today we are talking about windfalls. We are talking about those moments that you might find yourself coming into a lump sum of cash and you're wondering what to do with it. This conversation was sparked by a question from Sadaf, who asked how we would approach getting a lump sum. If you want to ask a question for Bryce and I or for some of Australia's best financial advisors hit us up at ask@equitymates.com. But Bryce, before the break we spoke about some of the key rules. Rule number one, be aware of the tax treatment of your lump sum. Rule number two, time is your friend. Don't rush. And number three, invest sustainably. Let's talk about how we would manage it. As someone who meticulously takes all accounts, all of his deductions each tax year and also has a propensity for committing tax fraud, I'm not sure.

Bryce: [00:15:26] Not true. 

Alec: [00:15:27] What how how do you approach getting lump sums? [00:15:29][2.5]

Bryce: [00:15:30] So there's sort of three lump sums that I've had. The first is the tax return. And I think when I was at uni, I've treated it completely differently to how I treat it now. In fact, I would say that most of what we've spoken about is not how I traded my tax return at uni, because the tax return at uni was probably the most money you would ever come to at one point in time and I probably spent too much of it. The second was the bonuses at work, which we were very fortunate to be able to get, and in those instances I would invest as much as I could. I guess that's the invest sustainably. Then we did win. My wife did win the

Alec: [00:16:12] No we about it. Harriet did all the work. 

Bryce: [00:16:15] Harriet won who wants to be in hot seat, millionaire hot seat and and it's public. So she won, She won $50,000 which is a significant windfall. Very, very fortunate. And, you know, the temptation was there to be like, we want to buy this. We want to buy that. 

Alec: [00:16:31] Well, for people that watched that episode of Millionaire Hot, Harriet committed to Eddie McGuire, that she would make a profit, I think is a pretty ingenious idea. People are probably familiar with Sushi Train. Where different selections come out in little plates on a train and you can pick what you want. Harriet was going to take the money and make a pass to try. There's a little survey. Six different pastas and you can choose what you want. An idea that I think has merit.

Bryce: [00:17:04] It does. 

Alec: [00:17:05] Has a business plan going. 

Bryce: [00:17:07] Nowhere. 

Alec: [00:17:08] So. Bryce dust Harriet strains of a pasta train and here's what he did with the money instead. 

Bryce: [00:17:13] The bit in rule number two is what really really helped us here which was. Don't blow it. Time is our friend. Let's sit it in a savings account and just see how we feel about it over a period of time. And it fast became a I'm glad we haven't spent it, because we then got into buying a house mode and it became very, very helpful towards that. So I think if we were to look back and if we had spent it in any way that wasn't building wealth, we probably would have regretted it. So that time. 

Alec: [00:17:44] You guys didn't do anything fun with the money? 

Bryce: [00:17:46] Not a single thing. Yeah, I know. I know. She still has the full to the cent for 50,000. Well, I mean, we bought a house. Yeah. It's got, it's gone to that but like. 

Alec: [00:17:56] Oh but you haven't actually settled down. 

Bryce: [00:17:58] Haven't settled the house yet but it's to the cent not a cent was spent of it. Yeah. I mean we didn't do it. Yeah. We thought about it and then we were like you know, because she was like, oh, you know, I'll trade my friends to like a weekend away or whatever. And then she's just like, What's the point? Like? 

Alec: [00:18:16] I don't know, might be fun. 

Bryce: [00:18:17] Like, We could just do that and I'd be happy to pay for a weekend away as a group of friends anyway. So I don't know, she And then we were going to buy a new mattress because we need one, but then didn't do that because we're just like, we're going to end up doing that with the new house anyway. So I don't know, it just sitting it out of sight, out of mind was the right thing to do. Yeah. Yeah. And any windfall now I just try and get in the market. Yeah. Because it for, for me it comes down to it's not part of the budget and we're happy with the budget that we've set. We don't need to get a tax return to achieve the goal or whatever. So I say this is like lucky to have been fortunate you've worked hard. Unfortunately, it may have come through a redundancy or something like that, but building wealth with them, if you can, if you can, I think it's fortunate position. That's how we think about it. What about you? 

Alec: [00:19:06] So two things. First of all, you know, I've never had a $50,000 TV gameshow win, so it would be nice if I could, but I think so for me personally, right now, it's just put it in the stock market like it's not rocket science or actually because on buying a house, it would be put it in my high interest savings account where I've got my house deposit. Yeah, but that's probably the first thing. The only other thing I would think about, especially if it was a redundancy payout, is would be beefing up my emergency fund. And so, I mean, honestly, if you get a redundancy until you get a new job, you're not investing that money. You're putting it in a high interest savings account and drawing on it as you need to cover your living expenses until you get a new job. And then you can start thinking about how much, where, what goes where. But yeah, I would if I got, you know, like if I won lotto or something like that, I would probably beef up my emergency fund from three months of expenses to maybe six or, you know, maybe at least another month in there just to. Err on the side of caution, especially because now that emergency fund is getting an okay return in a higher trust savings account. So it's not like it's money that isn't working. So that would be probably my first thing. Just think about like how much I want to set myself up for, you know, a rainy day. And then other than that, it would just be a house deposit and investment. Luckily, I'm not in any debt, but I think if I was, that would. Well, actually, sorry, that's a lie. I am in HECS debt, but I just don't even think about HECS. I know, I know. Some people are really focussed on clearing HECS and I know that feeling was really amplified with the indexation. But for me I'm pretty sanguine. Like I'm pretty okay with HECS. I understand that this year it'll probably be indexed pretty high as well. It'll be like based on where inflation is now this financial year, I will probably get like a 5% indexation and there'll be a lot of noise about it at the time, but I expect to earn more than 5% from my investing. 

Bryce: [00:21:23] Nice, well let us know what you would do with your windfall. Come and join us in the Facebook discussion group Equity Mates Discussion group and we'd love to hear from you. 

Alec: [00:21:32] Now Bryce, before you wrap just one fun fact in our book, Don't Stress Just Invest. We ended each chapter with just an interesting financial story or anecdote. You know, the term keeping up with the Joneses. Yeah, It's like. You see, your neighbour gets a new car or yeah, does a renovation and you feel the need to do it. Now that you're or you're soon to be a homeowner, that's going to be a feeling that you have to deal with. There was a study done by the Federal Reserve of Philadelphia and they looked at Canadian lottery winners and the bankruptcy claims from 2004 and 2014. And so we wrote about that in the book, just pulled out some of the key findings. There's a massive keeping up with the Joneses effect that when someone wins a lottery, at least in the Canadian data, when someone wins a lottery, the rate of bankruptcy claims from their neighbours spiked really massively. And looking at what the neighbours were spending on it wasn't non-visible goods like, you know, furniture inside of homes and stuff like that. It was all visible goods, like those obvious displays of wealth to keep up with the lottery winning neighbours. So here's the stats. So the Federal Reserve also found the amount of money borrowed, the amount of credit card debt also rose relative to the amount one. So like the bigger the lottery win, the more borrowings and credit card debt that followed, They found that for every $1,000 more in lottery winnings, there was a 2.4% higher probability of a neighbour declaring bankruptcy.

Bryce: [00:23:06] What on earth? 

Alec: [00:23:07] So keeping up with the Joneses is real. Just one of the interesting facts you'll read about in our book Don't stress, just invest. And so our final thought to leave you with as we close out the window for discussion is if a friend, a family member or a neighbour gets a windfall, don't feel the need to keep up with them because as this data found, that's a fast track to bankruptcy Wealth increases. The beauty of bankruptcy is fascinating. 

Bryce: [00:23:35] Ren, we'll leave it there, but please come and join the conversation. The Equity Mates Facebook Discussion Group. And if you'd like to ask a question, as we close out the year, shoot us a question at ask@equitymates.com. But as always it's great to chat and we'll pick it up next week.