“Spending is quick, earning is slow.” – Russian Proverb

For the past eight years, my wife and I have been self-employed.  We correspond at least quarterly with our CPA to ensure that we pay the correct amounts on our estimated taxes.  Since our business income and expenses can vary so wildly, we’ve pretty much given up on trying to forecast the number at the beginning of the year.

Our most recent communication with our CPA delivered some very good news.  Our daughter’s adoption, which was finalized in April, means we will qualify for the Adoption Tax Credit.   Since the adoption was considered a special needs adoption, and qualified for the Adoptions Assistance Program, we’ll be able to claim the full 2009 credit of $12,150.

That’s quite a windfall.

Although we knew that we’d be eligible for the Adoption Tax Credit when our daughter’s adoption was finalized, we didn’t count on it happening this year.  Even though she’s lived with us for nearly three years and was never going to be reunited with her birth family, a queer-unfriendly social worker turned what should have been a straightforward older child adoption into a year-long legal battle.  Even after we won the right to adopt, our agency stalled for another six months before finalization.

We didn’t count on the credit because, quite frankly, we weren’t sure the adoption would ever be finalized.

Since we’ve been dutifully paying our estimated taxes assuming we wouldn’t get the credit this year, we’ll probably be able to skip our Q4 tax payment altogether, and we’ll likely end up with a refund after we file.  This is amazing news, because in all the years we’ve been self-employed, we’ve never had a refund.  Most years, we’ve ended up owing more on April 15th.

Our initial reaction was a collective shout of “Whoopee!”  Once we finished cheering, we started listing all the wonderful things we’d like to do with the money.  There were repairs to be done around the house, holiday and birthday gifts for ourselves and our friends, and maybe even a vacation somewhere.

Then, I had to be the killjoy.  As lovely as repairs, gifts and a vacation sounded, I realized we needed to be sensible.  Windfalls like this don’t come around very often, so we needed to use the money wisely.  After considerable discussion, my wife and I came up with the following ideas:

Emergency Savings – Although my wife and I have managed to save up about $7,000 for emergencies, it’s not enough to sustain our family over a long period of illness or unemployment.  Adding a large amount of money to that account would go a long way towards our peace of mind.  It wouldn’t be a hedge against all disasters, but emergency savings to cover four to six months of living expenses could go a long way to help.

Investment – My wife and I have several retirement accounts each, including 401(k) rollover accounts from past employment, and SEP-IRA accounts that we’ve used since we’ve started our business.  Despite making efforts to contribute to these accounts over the years, we don’t anywhere near enough to retire.  The drop in the stock market really hurt our accounts, shaving off nearly 50% of their value.  It’s tempting to invest a large part of our windfall, so we can play catch up.

Debt Abatement – Since my financial implosion and my wife’s episode of financial infidelity, we’ve made keeping the credit cards paid off a high priority.  Not having any high-interest debt is a great relief, but we still have 27 years of payments remaining on our home mortgage, and another 18 months on an automobile loan.  Retiring the automobile loan would be nice, as it would free up $325 per month that could be allocated to emergency savings, investment, or higher payments on our mortgage.

After carefully weighing all the options, we came up with the following plan:

1.    Pay off the auto loan.  Although the interest rate is fairly low at 5.64%, we decided that paying extra money for the car just doesn’t make sense.  Our savings accounts and investments aren’t doing nearly as well, so saving 5.64% in interest is worth more to us than earning the 1.3% our savings account collects.

2.    Contribute to emergency savings.  Whatever is left after the auto loan is paid off will go to our emergency savings account.  We’ll also redirect our former car payment to emergency savings as well, until we’ve accumulated enough cash to cover at least six months of living expenses.

3.    Invest after the emergency savings are funded.  Although we’ll continue to contribute small amounts to our retirement accounts as we’ve done all along, we are going to redirect the bulk of those contributions to our emergency account.  Once we’ve got our rainy day fund covered, we’ll redirect our old car payment to our retirement accounts.

4.    Accelerate our mortgage payoff later.  Once all our debts are paid off, our emergency account is funded and we are making steady contributions to our retirement accounts, we’ll start adding a little bit extra to our mortgage payment every month.  As the economy gets better, we’ll try to increase this amount in the hopes that we can ultimately shave five to ten years off the life of our mortgage.

Next in series: The Importance of not Counting Chickens

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