Dear Rick:
I have a few questions I hope you can help me with. Last year I received a gift from my grandparents. It was $18,000. My first question is do I have to pay tax on the money? My next question deals with what I should do with the money. My financial situation is not good right now. I got divorced a couple years ago, and I have not done a very good job with my finances. Currently, I am living with my parents and eventually would like to get an apartment. I am working and have been able to save money. My financial situation is I have an outstanding car loan for $8,000 at eight percent interest. I also owe about $15,000 on my charge card at 22% interest. The only other debt I have is a student loan for about $12,000 at seven percent. I am currently fully funding my 401(k) at work and am saving about $500 a month. Do you think I should pay down my debt or use the money from the gift to get an apartment?

Thank you.

Susan

Dear Susan:
The good news is that the money you received from your grandparents is not taxable. When you and I receive gifts, we are not liable for any taxes. In fact, the way our gift tax laws work is the person who is giving the gift would be liable for any taxes. In the situation at hand, your grandparents are not liable to pay any taxes because of the amount of the gift.

With regard to the money, without question, I think you should use the money to pay down your debt. Since you are paying 22% on your charge card, and that interest is not tax-deductible, when you pay off that debt you are getting a guaranteed 22% after tax return on your money. I can assure you, no investment has such a large guaranteed rate of return. Therefore, the first thing I would do is to pay off your charge card debt. After that, I would use the remaining money to pay down the car loan, which is at a higher interest rate than your student loan.

My thought is that by paying down the charge card and reducing your car loan debt, it is going to give you more flexibility when you start looking for apartments. In addition, it would make you more attractive to a landlord. In today’s world, landlords are looking at people’s finances, and the fact that you would have no charge card debt, would make you more attractive as a tenant.

I also think there’s another benefit of reducing your debt, and that is sleeping at night. All too often people who are in severe debt find that their health is adversely affected. The fact that you would be able to get rid of half your debt would dramatically ease the pressure on you.

My thought is that since you are fully funding your 401(k) plan, which I think is great, you can then take the money that you are using to pay off your debts and to begin to save that for your eventual move. I recognize this may put off moving for a few years; however, it would significantly improve your financial health.

Whether someone receives a bonus or unexpected gift, the key is to use that money wisely. As far as I’m concerned, paying down debt, particularly high-interest rate charge card debt, is a win-win situation. Not only will it improve your financial health, but it will also take a lot pressure off you which will also help your physical and mental health. Therefore, for those who are lucky enough to receive a bonus or a gift, make sure you spend it wisely. I recognize that using the money for a luxury item or trip is wonderful; however, I would also tell you that in the long run, reducing your debt and no longer letting it control you is a much better choice.
Good luck!

Rick is a fee-only financial advisor.  If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.