A windfall can come into our possession in a number of ways: a big gambling victory, a winning lottery ticket, or an inheritance from a deceased relative. No matter how it’s attained, one constant is the emotional pressure an influx of cash puts on the recipient. Not only can a cash windfall send you on an emotional ride, but it may leave you with an abundance of questions. Primarily, you may be wondering what you should do with a windfall. To assist you, we’ve outlined a few processes to go through when deciding how to manage this new sum of money.
If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.
Decide on Your Payment Options
If you received a bonus from work or a large prize payout, you might not have a choice on payment options. However, lottery winners are given the option of receiving a lump sum or installments.
For many people, the lump sum payment may be more beneficial. The windfall is maximized through the lump sum payment thanks to the time value of money and no loss of purchasing power due to inflation.
For example, let’s say you take home $1 million (post-tax) in lottery winnings, and have the choice of a lump-sum payment or monthly installments of $16,666.67 over 5 years. By taking the $1 million upfront, you could invest $500,000 in the market, purchase a $300,000 home, and save the rest. But with the installment plan, your winnings will slowly be eaten away by inflation, and you could be stuck with a severe case of FOMO if the market roars during the five years you’re collecting installments.
Many people choose the installment plan because it prevents the money from being spent frivolously. If you struggle to control spending and worry about blowing the money (a recurring theme amongst lottery winners), then the installment plan may work for you. But if you want to work towards maximizing every dollar of your windfall, a lump sum payment probably makes more sense.
Consider Your Potential Tax Burden
A cash windfall might be exciting, but the IRS will want their cut too. You’ll need to figure out what the tax burden on your windfall will be before deciding what to do. If you receive your windfall through lottery or prize winnings, it will be taxed as income. If it came from an inheritance, the tax implications will be different. Always consult with a tax professional if you aren’t sure what your burden will be.
There are also ways to reduce the tax burden on your windfall, such as contributing to a qualified retirement account or gifting money to friends or relatives. In 2020, the contribution limit for 401(k) accounts is $19,500, and for IRAs, it is $5,500. Additionally, cash gifts of $15,000 or less are non-taxable according to the 2020 Gift Tax annual exclusion.
Put Your Money To Work Where It’s Needed Most
No two windfall recipients will have the same needs. While building a diversified stock portfolio might make sense for some people, others might prefer to pay down high-interest debt or purchase a home. But no matter your current financial situation, it’s important to deploy the money where it’s needed most. Some common uses for a windfall include the following:
- Paying Off Debt. It’s usually a good idea to pay off high-interest debt like credit cards. If you carry a balance on cards with interest rates, pay them off first. Then move to other types of debt like student loans, car loans, or mortgages.
- Emergency Savings. Not everyone is comfortable putting money into risky assets like stocks or bonds. But it’s still crucial to get something out of your cash, so consider a high-interest savings account for emergencies. Many online savings accounts offer rates as high as 1.5%.
- Investing. Getting into the market is a great use of windfall money, but there are plenty of vehicles and investments to consider. If you have children approaching college age, a tax-sheltered account like a 529 Plan might be ideal for your cash. Or perhaps you can start a new IRA for retirement.
- Fun. Why not splurge a little? We’re all human and a cash windfall gives us the urge to spend, so why not responsibly feed that urge? If you have a solid plan in place for your money, it doesn’t hurt to treat yourself to a nice new toy. Money management doesn’t have to be all stocks and spreadsheets—if you’ve had your eye on a new TV or exercise bike and a cash windfall can make that purchase a reality, don’t feel guilty about going for it if it’s within your means.
Discuss With A Financial Advisor
When asking yourself what you should do with a windfall, it’s crucial to discuss with a qualified financial advisor. An advisor will help you set up a plan for your new money so you can work towards getting the most out of it. If you need assistance, reach out to a team member from Good Life Financial Advisors of Mount Pleasant. We can help point you in the right direction and make sure you continue to pursue your financial goals.