Getting an unexpected cash windfall can be exciting. Maybe you won a small contest or got a bonus at work. Or perhaps you got really lucky and won a lottery prize worth tens or hundreds of thousands of dollars.
You can’t rely on a windfall to solve your financial problems. But you certainly can prepare for the possibility. Read on to learn how to plan how best to use a large lump sum of cash and avoid the temptation to spend it frivolously.
What to Do With a Windfall of Cash
Here are some of the first things you should do if you get a cash windfall.
1. Speak With a Financial Advisor
A large financial windfall could be more money than you’ve ever had in your bank account before. If your windfall was semi-public, such as a lottery win or inheritance, expect friends and family members to start asking you for money.
This is a stressful situation. To manage it, consider working with a financial advisor who can help you make important financial decisions.
Look for a fee-only financial advisor sworn to act as a fiduciary. Instead of charging fees based on your assets, these advisors charge flat fees for a financial plan or a per-hour fee. They’re also sworn to act in your best financial interests rather than their own.
A financial advisor can give you advice about:
- Creating an estate plan that protects your loved ones
- Paying taxes and dealing with the IRS
- Determining the best asset allocation for your investments
- How to manage, protect, and use your sudden wealth
Smaller, less public windfalls like a big tax refund can still be a good opportunity to improve your finances. However, they probably don’t require a meeting with an advisor. This is especially true if you’re just adding the cash to savings or paying down debt.
2. Pay Off High-Interest Debt
Many Americans have some kind of debt to their name. The average millenial alone is more than $80,000 in debt, according to Experian. Student loans are particularly impactful, with the average Gen Xer owing more than $40,000.
Whether it’s student loans, a mortgage, an auto loan, or a credit card balance, being in debt means having to worry about paying your bill every month.
Some financial advisors differentiate between bad debt and good debt. Good debt is debt like a mortgage, which typically has a low interest rate and helps you buy a valuable asset.
Bad debt includes things like personal loans and credit card debt. These debts typically don’t help you purchase valuable assets and carry high interest rates, making them very expensive in the long run.
One of the best things that you can do with a cash windfall is get rid of bad debt. This eliminates some of your monthly bills and helps you save money on interest.
3. Build an Emergency Fund
The number of Americans who can’t afford to pay for an emergency is staggeringly high. Just under 40% of Americans have enough cash in the bank to handle an unexpected $1,000 expense, according to Bankrate. When you can’t afford an unexpected bill, you may have no choice but to use a credit card or personal loan to cover it.
That’s why you need an emergency fund
A general rule is to keep between three and six months’ worth of expenses in their emergency fund. For example, if you spend $3,000 per month, keep between $9,000 and $18,000 socked away for a rainy day. That amount of money should be sufficient to cover most minor emergencies and help you get through larger events like losing your job.
Keep your emergency fund in an online savings account with low minimums, few fees, and a competitive interest rate.
4. Fund Your Retirement
You don’t want to keep working into your 70s and 80s because you didn’t set aside enough cash. You also don’t want to find yourself unable to work due to age and having to find ways to scrape by on a low income.
If you get a financial windfall, saving for retirement can help you prepare for the future and reduce the amount of taxes you have to pay.
Set up an Individual Retirement Account (IRA) or Roth IRA and contribute to it each year. You get to deduct the amount you contribute from your income when filing taxes, meaning you pay less tax in the years you contribute. The same is true for 401(k) contributions if your employer offers one.
These tax benefits make retirement accounts a popular financial planning tool and one of the best ways to prepare for retirement. If you don’t feel comfortable investing the money on your own, your financial advisor can help.
5. Save for Your Children’s College
The cost of an education in the United States has skyrocketed over the past decades. According to the National Center for Education Statistics, tuition at the average 4-year school more than doubled between the 1985-86 school year and the 2018-19 school year, rising from $12,811 to $28,123.
Many students graduate college with tens of thousands of dollars in student loan debt, delaying key financial milestones like buying a home or starting to save for retirement.
Helping your kids pay for college gives them a head start in life. Start by opening a 529 savings plan for each of your kids. A 529 plan is a special type of investment account designed for college savings and other educational expenses.
Your 529 plan contributions grow tax-free as long as you use the money for qualified expenses. Your home state’s 529 plan may offer additional state tax benefits as well.
6. Fix Up Your Home
It’s no secret that homeownership is expensive. If you own your home, use your newfound wealth to pay for all of the home repairs you’ve been putting off.
Focus on preventive maintenance and efficiency-enhancing projects like fixing up the roof, replacing your hot water heater, adding central air conditioning, or putting solar panels on the roof.
These improvements can help you avoid big expenses down the road or reduce your utility costs. They can also add to the value of your home, helping you build equity and increase your net worth.
7. Pay Off Your Mortgage
If your windfall is big enough to completely pay off your mortgage, consider doing so. Lots of money moves earn better returns in the long run, especially if your mortgage’s interest rate is very low. But few give you the same peace of mind or have comparable impact on your household cash flow
Owning your home outright means no more mortgage payments. You’ll still incur housing costs like property taxes, utilities, maintenance and repairs, and possibly homeowners insurance. But not putting money toward a mortgage means a lot more cash available for other spending or saving each month.
8. Donate Money to a Good Cause
Donating money to charity helps support causes you care about and can help you feel good about yourself. Plus, charitable donations can reduce your taxable income, meaning you can pay less tax on the windfall you received. So, if you have a favorite charity or non-profit organization, consider donating a portion of your windfall.
If you received a very large sum of money, you have more options to use the funds for good. Consider setting up a donor-advised fund or charitable trust to give yourself more flexibility to donate money over the long term.
9. Splurge, But Only a Little
If you buy a winning lottery ticket or even just find $20 on the sidewalk, it’s natural to want to splurge and treat yourself to something nice. Splurging isn’t necessarily a bad thing, but it’s important to make sure you don’t spend all of your money frivolously.
You can set aside a small amount of money from your windfall to satisfy the urge to treat yourself. If you take 5% of your windfall and designate it for fun purchases, that can help you remain disciplined with the remaining money.
While you figure out how to use the remaining money and come up with a financial plan, do your best to separate it from the funds you’re splurging with. Putting the cash somewhere in your home instead of your wallet or placing it in a different bank account is a good way to keep it out of sight and out of mind.
If you find yourself receiving a cash windfall, wanting to do something fun with it is natural. However, long-term thinking and careful management will help you turn a windfall into a long-term improvement in your standard of living.
Sometimes, the best thing to do is to simply take your time and not make any sudden moves. Put the money aside in a certificate of deposit (CD). This keeps it safe and locked away for a few months. You can use the time that the money is tied up in the CD to get used to your newfound wealth and plan to use it wisely.
This is also the perfect time to choose how you’ll split your money between savings, investments, and paying down debts. If needed, consult a financial advisor to help you make those decisions. Once you have a plan, you’ll feel much more comfortable handling the financial windfall you’ve received.