What to Do With a Sudden Windfall?
When you receive a sudden windfall of money from an inheritance, a legal settlement, winnings or as a gift, you may be wondering about the best plan of action for your money. This extra cash is an opportunity for you to improve your financial situation, but many people fritter away the money because they don't have a specific plan to preserve it.
If you have the good fortune to find yourself in this situation, there are several steps you can take to make the money last and set yourself up for a potential early retirement while still having a little extra fun along the way with your newfound wealth.
Determine Your Tax Implications
First, consider the tax implications of the money that you receive which depend on where the money comes from as to whether or not it is taxable. Talk to your tax accountant or another financial professional to determine whether or not the money is considered exempt from taxes. Most money is not, so you should set aside enough money to cover the taxes or pay the taxes now.
Consider Different Payouts
If you have the opportunity to take the money in monthly or annual payments rather than a lump sum, it could help you curb the temptation to splurge. Lifestyle creep is a real risk when you suddenly have extra funds and spend just a little bit more here or there over time. If you can take the money in annual payments, you may also be able to spread out your tax liability over time, but speak to a tax professional for more insight.
Set Aside a Small Portion for Fun
Allow yourself a small percent to use for your enjoyment or entertainment. Generally, this should be no more than 10 percent of the money. Use this money wisely. Shop the sales, wait for prices to drop, and look for other deals so you can get more value out of the amount of money that you spend. You may get hit with peer pressure to spend all of your money on fun instead of using it wisely. It is important to have fun but you should track your spending and stop as soon as you reach the amount that you set aside.
The majority of the money should be used to cover other expenses and invest for your future.
Set up a Financial Plan
Before you make any additional decisions with your money, you need to create a financial plan if you do not already have one. If you've already done this, you may want to adjust your goals. Consider updating your goals and putting the bulk of the money toward your long-term financial plan. This way, you can speed up the process and reach your goals much more quickly.
Create or Update Your Estate Plan
If you already have an estate plan, it makes sense to revisit it periodically anyway, but you may have significant changes to make after receiving a windfall. It's important to have an estate plan in place to ensure that your money is distributed exactly according to your wishes upon your death. A detailed estate plan can also make the wealth distribution process much less upsetting for your grieving beneficiaries as well.
Pay Off Your Debt
If you still have debt payments, you can use this money to pay off your debt. However, if you are not fully committed to staying out of debt then you should invest the majority of the money. Otherwise, you will simply run your debt back up in a few years and you will have nothing to show for the windfall. If you already have a firm financial plan the first step should be to get out of debt. Once you have paid off your credit cards, you may want to close the accounts.
Create an Emergency Fund
After you have gotten out of debt you should create an emergency fund of about six months of your income. This money should be put in a high yield savings account. This money should only be accessed for true emergencies such as a job loss or medical emergency. When you dip into your emergency fund, you need to replenish it with your monthly income. For all other expenses, you should plan and save for them.
Invest Your Money
After you have funded your emergency account, invest the rest of the money. Find a good financial adviser to help. One way to invest the money is to choose quality mutual funds with a good earnings track record and low fees that match your risk tolerance and investing objectives. You may find a financial adviser through your bank or through referrals from a friend. Mutual funds spread the risk over several stocks, but you should also diversify your investments over a few different mutual funds and mutual fund types in order to minimize your risk.
Pay Off or Consider Buying a Home
If you don't already own a home, this money may make an excellent down payment for the home or to purchase it outright. You may choose to invest a large portion of the money and use some of it on a down payment. If you do purchase the home outright and have funds remaining, invest the amount that would have been your house payment each month so that you can really begin building wealth. Additionally, owning a home outright can free up the money you earn each paycheck so you can add additional money to your investments.
Take Care of Your Financial Responsibilities
You may find that you have financial responsibility for another person in conjunction with the windfall. For example, your parents may have passed away and you have become the guardian of your siblings, so you need to plan with those responsibilities in mind.
It is important to make sure their needs are met as well as your own through a trust or similar financial vehicle that protects and preserves money that is rightfully theirs. It may also change your long-term career plans and education plans. You may want to consult a lawyer and set up a trust for the money that will help cover education expenses for your charges. A properly structured trust can help protect the money in a variety of ways, especially if they are not making the best choices once they are 18 years old.