Money...

I was browsing through some blogs this morning and a couple caught my eye because they were pondering what life would be like with a million dollars. I have had similar "what if" chats with friends before and while many of the conversations are very "pie in the sky", a fair amount have been pretty realistic. Many people that I have chatted with said paying off debt and buying homes were the first thing on their list while others stated they would give gifts to those who meant a great deal to them.

In my pondering of "what if I had a million dollars", I have come to the conclusion that one million is really not that much money. Please, hear me out.

Pretend you are Joe Employee at a medium to large company. Let's say you earn 50,000 a year and are buying a small home. In 20 years you would earn one million dollars, providing you never received a raise and you made that 50K each and every year. Could you stop working and live on that one million dollars? I seriously doubt it.

I am of the school of thought that it would take five million dollars for a 40 year old man to be able to quit working and live AT HIS CURRENT quality of life, more if he wants to "better" himself. While I understand that this is not exact, the concept is sound.

Let's go back to the first part of this...you are a 40 year old man who makes $50,000 a year, You are buying a home and have wife and one child. While you are not wealthy by any means, you can live (frugally) on your $50K a year. You win a 5 million dollar lottery and decided to take the lump sum payout, which is usually about half of the money, in this case 2.5 million dollars. In your first year, you will have to pay the IRS their share (roughly 1.25 million) and then you have the rest to live off of for the rest of your life.

Now the next part considers the very real possibility that all the money you have paid into Social Security is no longer there. With that in mind, you have to ration the money you have to last you and your wife for the next 40 years. 1.25 million divided by 40 years equals $31,250 per year. Now you are no fool, so you invest $500,000 into mutual funds that historically give you 10% yield per year. You decide to live off of the $750,000 for 20 years and use the Mutual Funds to retire on. $750,000 divided by 20 years equals $37,500 a year for you to live on until you are 60. Assuming that your mutual funds give you 10% and you invested $500,000, you could get about $5,000 a year profit to take out to augment your $37,500 to about $42K / year...still below your 50K you live on now. The $500,000 you invested would remain at $500,000 (if it always returned 10% per year and you withdrew that 10% each year) so you could use it to start living on when you reached 60, but that money would only give you 10 years at 50K a year to live on (not counting the interest accrued during from ages 6 to 70). If you live to 75, you are 5 years broke and if you live longer...well you get the picture. Taking a lump some of a 5 million dollar lottery at age 40 would not guarantee an easy life if you stopped working. Again I am not accounting for Social Security and any pensions you may have built up.

I ran the model allowing for the 5 million to be distributed over a 20 year span in equal YEARLY payments. With this model, I can get 250,000 a year, give half to the government every year and have$125,000 to live on each year for 20 years. Out of that 125K, I would invest 50K every year for the 20 years I received my yearly payment into a mutual fund. That fund would make 10% (conservative estimate) and I would not have to touch that money until I reach 60, the same time my checks stop. At that point, I would have one million dollars in Mutual Funds that I could withdraw 50K at time to live on and be OK for 20 years NOT COUNTING INTEREST.

Taking a lump sum is a tricky move, since most lotteries stop paying if you die. If you were older than 45-50, I would take the lump sum. Under that age in reasonably good health I would take the payments.

Taking 50K and investing it and leaving 75K to live on a year is great if you are used to living on 50K a year, since most of us would like to get out of debt. I personally would not rush to pay off my house, but make extra 5K payments each year to pay it off sooner, allowing the bulk of my money to earn interest since the 10% return that is common in Mutual Funds is greater that the 5.25% interest I am paying on my mortgage. If I had an annuity calculator, I am sure that I would be pleasantly surprised on the money I would have to live on using this model.

So using my thoughts as a loose guide...how would you spend $5 million?