Ask Paul: What should we do with a $100,000 windfall?

Rob: I'm 40 and work full time, earning $70,000; my wife Kim is 33 and is full time at home with our toddler and new baby.

Recently we have received a payout of $100,000. Our primary residence is worth $700,000 with a loan of $495,000.

We have two investment properties, one worth $270,000 with a loan of $250,000, the other worth $340,000 with a loan of $300,000 and rented at $270 a week.

What do we do with the money?

At present it sits in our offset account. Our self-managed super fund is ticking along nicely, however I would like to reduce some debt. What is the best way forward?

You know, Rob, once in a while I get a question that I feel I can answer simply and concisely. Thank you.

You cover all the key issues: your ages, salary, children, property values, super and in particular a clue in that you want to reduce debt.

So my opinion is equally clear. Leave the $100,000 in your offset account.

This also leaves me with a pleasant opportunity.

As I don't have to use my 900-word allowance that Money's deputy editor, Maria, gives me (and I get into trouble if it is too long or too short) to look at a wide range of issues, I get to do a bit of modelling for you.

We all have goals and aspirations, so I am curious to look at your situation as you approach what today is called retirement.

Retirement is a really silly word and it should be dumped.

It did not exist before the early 1930s. A small percentage of people were really rich but the other 97% of us just worked and died.

Even in 1908, when the age pension was established, it was only for the odd exception. A male, for example, needed to be 65 and the average bloke died at 54.

Today, Rob, your life expectancy is 38.4 years, so about age 78. Your wife is 49, so 82. This does not include the "staying alive" dividend.

Life expectancy has been increasing by three months a year for over 160 years so you would be smart to assume a real chance of living longer.

So I want all of us to forget retirement and aim for financial independence. I suspect that, like me at age 61, most of us will plan to work at least some of the time for stimulation, social benefits and some cash. This is much more fun if we are financially independent and we work longer out of choice, not compulsion.

I want to be conservative, so I will assume that you or your boss is able to put around 10% of your salary into super - that is $7000. You have a SMSF.

These are hopelessly expensive unless you have around $200,000 or more, so I will assume $200,000. I am going to go with no additional payments into your mortgage as your wife is at home and two young kids are expensive.

I am going to grow your properties by 3% above inflation and your super by 10%, from your salary and the fund investments at 5% above inflation. I'll assume your income does not grow above inflation and that your wife does not return to work.

My time frame will be 25 years, taking you to 65, and I hope the numbers show you will be financially independent. In that 25 years I am assuming your mortgage is paid off. I will leave your investment property loans as they are today but as we are working in "real" numbers the value of these loans will be lowered thanks to inflation.

So, here we go! These are real values, with the same buying power as today but in 25 years.

Your house: $1.5 million. Investment property 1: $571,000, real value of loan $120,000. Investment property 2: $719,000, real value of loan $165,000. Your super: $1 million.

Let's keep it very simplistic and assume you continue to live in your paid-off house, so your investment assets in today's dollars are some $2 million. At 65 I would be happy for you to draw 5% of that amount each year, so you would have $100,000 to spend.

This is pleasing, as it says that just doing what you are doing will get you to financial independence. What could go wrong? Sadly, the answer is ... how long a list would you like?

First, my underlying assumptions could be wrong.

While they are historically conservative, I have no idea what the world will look like in 25 years. Your life may change. You may earn more or less, your wife may go back to work, you may get ill.

But there is nothing like a plan and a predicted outcome.

As I have navigated my way through life, I have always had a plan, be it money, holidays or racing my boat to Hobart.

I recently found our 1983 budget, for our first year of marriage. It had earnings of $15,500 and spending of $15,360, hence projected savings of $140.

Our income and expenditure have changed enormously but the sense of control, in that we always planned to spend less than we earned, was very powerful.

Speaking of powerful, my word limit is up and I can feel Maria frowning at me.

So, Rob, I do feel the answer to your question is clear and I hope you get a bit of a sense of "cause and effect" around what your money actions today will lead to in the future.

PAUL'S VERDICT: Aim for financial independence, not 'retirement'. Run through the numbers for a long lifetime.

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