The Newly Divorced Client With a Windfall and a Deadline
Mei, 47, finalized her divorce nine months ago. She received a lump-sum settlement of $420,000 and keeps the house, which carries a $310,000 mortgage at 6.1% with 24 years remaining. Her salary is $96,000 gross; she contributes 6% to her 401(k) (employer matches 50% of the first 6%), and has $38,000 in credit card debt at 22.9% APR spread across four cards. She has $9,000 in a checking account and no emergency fund. Her two children are 15 and 12; the college fund holds $55,000 in a 529 plan. Mei wants to retire at 62, fund both children's in-state tuition (currently $26,000 per year for four years each), and pay off the mortgage early. She has asked you to build a plan by month-end and is emotionally exhausted by the process.
1. Mei wants to use the settlement to eliminate the mortgage, the credit cards, and fully fund both 529 plans immediately. What should you do first, and how would you sequence competing goals?
Read the worked answer
The first move is not allocation but prioritization and stabilization. Three facts dominate: (1) she has essentially no liquid reserve ($9,000 against a $96,000 income and two dependents), (2) the credit cards cost 22.9% - a guaranteed, tax-free return no investment can reliably beat, and (3) the settlement is a one-time, non-replaceable asset that must also cover a retirement gap.
Recommended sequence:
- Emergency reserve: carve out 6 months of essential expenses (roughly $30,000–$36,000 given mortgage, taxes, and two teens) into a high-yield savings or money market account. This is non-negotiable before any payoff decision.
- Credit cards: retire the full $38,000 immediately. This is the highest certain return available and removes a cash-flow drag of roughly $725/month in interest alone.
- Retirement adequacy check: model whether the remaining settlement plus 6% deferrals reach a sustainable income at 62. Paying off a 6.1% mortgage is attractive but illiquid - home equity cannot fund groceries. Compare the after-tax mortgage rate against expected portfolio return, and note that mortgage interest may be partly nondeductible under the standard deduction.
- Education: fund 529s to a level consistent with the retirement result, not ahead of it. There is no loan for retirement; there are loans for college. Front-loading both 529s would consume the settlement and leave her retirement underfunded.
- Mortgage: a partial principal curtailment (not full payoff) preserves liquidity while reducing interest. Recast or reamortize rather than simply prepay if she wants lower mandatory payments.
Explain to Mei that the settlement is finite and that sequencing protects her from a second financial shock. Document the trade-offs in the plan.
2. Mei says she feels 'behind' and wants to invest the settlement aggressively in equities to catch up. How do you respond, and what behavioral and planning issues are present?
Read the worked answer
Acknowledge the emotion without endorsing the strategy. Her sense of being behind is real, but the settlement is a finite, non-replaceable pool with near-term claims (emergency reserve, children's tuition beginning in three years), so its risk capacity is lower than her risk tolerance feels right now.
Key points to make:
- Horizon mismatch: tuition for the 15-year-old begins in about three years. Money needed within five years belongs in stable assets, not equities. Bucket the settlement: near-term (reserve and tuition years 1–2) in cash/short duration; medium-term (tuition years 3–8) in balanced or short-to-intermediate bond exposure; long-term (retirement) in a diversified equity-heavy allocation.
- Behavioral traps: recency and loss aversion are driving the 'catch up' impulse after a stressful divorce. Also watch for mental accounting - treating the settlement as 'house money' rather than as her retirement and her children's tuition.
- Capacity, not just willingness: she has no emergency fund and a single income. A 30% drawdown on $420,000 would be roughly $126,000 - a loss she cannot absorb while also funding tuition.
- Process: complete a documented risk tolerance assessment, quantify the required return to meet her 62 goal, and show that a moderate allocation with a disciplined savings rate is more likely to succeed than a concentrated equity bet. Frame the 6% deferral and the employer match (50% of first 6%, i.e., a 3% employer contribution) as the highest-certainty return in her plan.
Offer a written investment policy statement and a review cadence to reduce panic-driven decisions.