Everyone dreams of it – receiving a windfall of cash either from a long-lost relative, a winning lottery ticket, or through a will from a grandparent who thought the world of you.
For most of us, that day may never come. But for some, the arrival of a financial windfall can change life in a single moment. There are important fiscal decisions to be made and ways in which a windfall should be managed before it goes to waste.
Managing a large lump sum of money can be a daunting task. It pays to take a strategic, long-term view of how to spend and invest it. Consider the following ten ways to spend and save a financial windfall wisely.
How to Spend a Windfall of Money Wisely
1. Pay off “bad” debts like credit cards or non-deductible, high interest loans.
Let’s say you have credit card debt charging 15% interest. By paying off this balance, you are essentially receiving an instant 15% return on your money because you are no longer paying the finance charges. Use some of the windfall to pay off high-interest debt. Then, try to stay out of debt for good!
2. Start or add to an emergency fund.
Start an emergency fund of 6 to 12 months worth of expenses in cash. Sure, a credit card can act as a safety net, but cash doesn’t charge you an APR and will let you sleep easier at night. Keep the money in easily accessible accounts which earn interest, like an account at ING Direct, Ally Bank, or similar.
3. Play catch-up with your retirement accounts.
Contribute a percentage of your windfall to your retirement accounts (i.e. 401k, Roth IRA, traditional IRA, or Roth 401k) to help ensure you’ll have enough money saved for retirement. In addition, some accounts will allow you to “catch up” and contribute additional funds if you are over 50 or did not take advantage of the maximum contribution limits in prior years.
4. If you have children, set up and contribute to college funds.
Use some of the money to start a 529 college savings plan. A 529 is a savings account designed specifically for college tuition that allows you to save money on a tax-deferred basis and even withdraw it tax-free if used for educational purposes.
5. Take care of home repairs.
Putting off a roof repair or a hot water heater issue can cost you a lot more down the road than what you save today. Use the money you recently acquired to protect and enhance your biggest investment – your home.
6. Pay down your mortgage.
Most financial advisors will tell you not to pay off a mortgage in full. They typically consider a mortgage to be ”good debt” because the interest paid is a tax deduction. However, you might consider paying a little extra each month towards the overall loan. By adding to each month’s mortgage payment, you can pay off your mortgage years earlier than expected and save money on interest over the course of the loan. Alternatively, if you’re stuck in a relatively high interest rate loan because your mortgage is upside down, you could pay that mortgage down to an amount where you qualify to refinance at a lower rate.
7. Donate some of the money.
If you have a favorite charity or non-profit organization, they could surely use a cash donation. So why not help them out? They get the donation and you get the tax write-off; it’s a win-win for all. See the tax deductions for charitable contributions and donations for more information.
8. Pamper yourself within reason.
Take a vacation, go to the spa, or head to that expensive restaurant. Taking a little off the top of that windfall to pamper yourself and splurge can do a load of good for your psyche. Just make sure it’s only a little and don’t get into spending habits you can’t afford to maintain.
9. Don’t rush into spending your windfall.
Calm down and think rationally about your new situation. Taking a few weeks or months to contemplate the possibilities can go a long way towards making sure you do the right thing. Assess your priorities and determine which areas of your life could most benefit from extra funds.
10. Consult with a fee-only financial advisor.
If your windfall is a public event (e.g. the lottery) you will start getting calls, letters, and emails from people wanting to “advise” you. Don’t listen to them; tell them you already have someone and then find and choose a financial advisor on your own. Since you can afford to pay them, definitely choose a well-referenced, fee-only advisor.
Bad Examples of Money Management
So, there you have it: 10 ways to responsibly spend a financial windfall should one come your way. And if that doesn’t do the trick in motivating you to be responsible, below are some stories of people who won the lottery and then managed to lose it all. Here are a few things NOT to do with a windfall:
- 16-year-old Callie Rogers won £1.9 million in a UK lottery and proceeded to waste her entire winnings on vacations, shopping, and breast implants. She now works a job to pay off the additional debts that she has accumulated. I guess that’s why you don’t give your kids a large allowance!
- Willie Hurt, who won $3.1 million in the Michigan lottery, ended up getting divorced, losing custody of his children, and getting addicted to crack cocaine. Oh, and he was also charged with attempted murder.
- When William Post won $16 million in the Pennsylvania lottery, his own brother hired someone to kill him so he could get his hands on the money.
- Janite Lee won $18 million in the Missouri lottery, but gambled it all away and ended up having to file for Chapter 7 bankruptcy less than 10 years after winning.
A financial windfall can be a gift if spent and managed wisely, or a curse if squandered or mismanaged. If you’ve recently come into money, take time to consider your blessing and what you’d like to accomplish with it.
What would you do with a surprise windfall? Do you know someone who received a large sum of money and managed it well?
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