8 Tips to Make the Most of Your Windfall Money

You’ve come into some unexpected cash – nice! When money drops into your lap – from an inheritance or a trust or insurance payout – the question is what to do with it? Should you save it, invest it or buy that boat you’ve been dreaming about? Some of that depends on the size of the windfall. The rest is how much money you want to make from it.

How much money is considered a windfall?

A windfall is a large sum of money, often unexpected. Large is relative. There’s no specific amount of money associated with a windfall.  For some people, a $1000 would be a nice windfall but for others, it would take upwards of $100,000.

A windfall can come out of nowhere, a winning lottery ticket or inheritance. It can also be a favorable outcome from a legal settlement, property sale, or an end-of-year bonus.  Often a windfall comes through an inheritance, trust, or life insurance payout. According to Charles Schwab, over 69% of Americans expect to leave their children an inheritance of around $177,000.

That’s a windfall for sure. But if we are to define the term – it’s not the amount that matters. A windfall is a one-time financial gain.

Tax Strategies

The type of tax you pay on a windfall depends on where the money came from. When money lands in your lap, get ahold of a CPA or tax attorney as soon as possible. You need to know your options.

Here’s how taxes break out: (For the most current information and options, always consult a tax professional.)

  • Lottery win: Taxed as income in your current tax bracket
  • Life insurance payout: No federal taxes owed
  • Inheritance from a spouse: No taxes owed
  • Inheritance not from spouse: Subject to federal estate tax when more than $11.58M (2020.)
  • Real estate or business sales: Any lump sum is taxed as capital gains

Be aware that some states also charge an inheritance tax. The estate size they use may be less than the standard set by the IRS.

The smartest thing to do if you land a windfall? Sit on it quietly. Don’t cash the ticket, don’t deposit the check. Find an accountant or a tax attorney and talk about your options. You may save yourself thousands in taxes when you consult a professional.

How to Invest Your Money?

financial puzzle

That’s the question of the hour. When you first get that check and put the cash in your account – it feels like the money will last forever. Might as well treat yourself. It’s almost as if the only thing better than getting a windfall is spending it.

There’s nothing wrong with doing something for yourself.  But as too many lottery winners know – a windfall won’t last forever. A windfall is an opportunity – don’t waste it.

(READ: Are You Building Wealth or Just Making Money?)

There are 3 approaches for taking advantage of a windfall:

  • Invest in Yourself
  • Passive Income Stream
  • Wealth Management

1. Invest in Yourself

If your financial house isn’t in order, this is a chance to set it right. This approach isn’t sexy or glamourous.  Depending on your situation, you may have some money left over. Even if you don’t, you’ll have a stronger foundation for your financial future.

Get out of debt

Everyone is always talking about paying off debt. Easier said than done when you’ve got a wallet full of credit cards and a family that uses them. Now’s your chance.

The average American family carries $7,027 in credit card debt. Car loans average out to $27,852 and student loans come in at $56,572, according to a study by NerdWallet.  If these numbers are accurate, the average American family is swimming in $91,451 of debt.  And that doesn’t include a mortgage.

Given the economic climate of the pandemic, more people are feeling a financial pinch.  This step is really about investing in you.

Credit Cards

The same study suggests we pay $1,155 in interest on our cards per year. Start with the account that has the highest interest account and pay it off.  Do it with every card you have until you run out of money. Once you have them paid off, decide what cards to keep open and what can be closed. Store-specific cards typically have the highest interest rates and don’t provide added value.

When your balance is at zero, see if you can negotiate your interest rate. Then stop using your cards for impulse buys. If you can’t pay it off when the bill comes due – is it really worth digging yourself into another hole?

Loans

Depending on the amount of your windfall, you can look at paying off your car note. If you have good credit and a low-interest loan, it may not be a priority. You can also consider refinancing the loan. If you’re trying to improve your credit, making monthly payments is the best way to do it. But if your payment history is poor, killing off the loan will take care of the problem. It won’t fix your credit, but at least it won’t get worse.

Student Loans

The amount of student loan debt in the U.S. is a shocking $1.55 trillion. A study by New York Life found that it can take up to 18 1/2 years for most people to pay them off. Deferring payments or refinancing can be complicated. The terms are different for government-funded loans or privately funded. But there is no pre-payment penalty on either type of loan.

If you can’t pay off the balance, alert the lender that your payment is for principal only. Otherwise, it will be viewed as advance payments. You want the principal reduced which shortens the term of the loan. (And the interest you pay.)

READ: (Should I pay off my mortgage now?)

Emergency Fund

Do you have one? If not, this is the chance to set one up. Go through your monthly bills – everything expense you have. Total it up and multiply by three if you have a two-income household with steady jobs. Multiply by six if you have a single-income household with one paycheck.

No one thinks an emergency will hit…until it does. A car accident, losing your job, an unexpected medical problem can put you behind in your bills.  If all you have to cope with is unemployment or your credit cards, your prospects are dim.

Use your windfall to make sure you’re covered in case of emergency. Put the funds in a high-yield savings account to make money on your money.

Max your Retirement accounts

If you already make the maximum contribution to your 401k or IRA, you can skip this. If you don’t, take a look at how you can max out this year.  A 401k has a $19,500 annual limit and up to $26,000 if you’re over 50.  An IRA allows $6000 a year or $7000 if you are over 50.  These contributions are “pre-tax” dollars and not considered income.

The same contribution limits apply to a Roth 401k or Roth IRA, but contributions are “after-tax” dollars. You need to pay income tax on your contributions. When you withdraw the money, it’s tax-free. 

If you don’t have a retirement fund, consider using your windfall to open one.

2. Passive Income Streams

Passive income is money that makes money with little or no labor. If you’ve got money to play with, passive income can be a steady stream of money hitting your account. Even if you don’t have a huge windfall – you can consider some of these investments.

Robo-Advisor Investments

Whether it’s Betterment or Wealthfront or Acorn, the market for small investors continues to grow. Acorn charges higher fees than the other two, but all have low minimums to open your account. These are robo-advisor accounts – everything is managed by algorithm. These accounts are as passive as it comes – you give them your money and that’s it. They take it from there.

Robo-advisors aren’t just for smaller investors. Many robo-advisors start with a $5000 minimum or more. Interactive Advisor splits their portfolio offerings – one bundle for $5000 minimum. The other bundle runs between $5000 and $50,000. Personal Capital has an account minimum at $100,000 and ELLEVEST’s Private Wealth accounts start at $1M.

Some of the accounts allow investors more control than others. But robo-advisors are designed for passive investors who are happy to let the algorithm work.

Peer to Peer Lending

helping hand up

Peer-to-peer lending (P2P) takes the bank out of the loan process. Individuals, or groups, put up money, and loan applicants create profiles. The interest on the loan is how you make money.

There are different platforms for P2P transactions designed for different types of loans. The interest rates are set by the P2P platform and start as low as 5.99% and go as high as 35.99% for personal loans. Funding Circle is specifically for small business loans, with rates from 11.99% to 30.12%. All the loans have a minimum and maximum amount. With the right borrower, the interest income far outweighs more traditional options.

Loan applicants across all platforms typically have a credit score of 600, but there is still risk involved. Investors are encouraged to diversify their investment. Instead of funding an entire loan, some platforms allow you to fund only a part of it.  If you have $5000 to invest, you can offer $100 on 50 different loans. If an applicant defaults on their payment – you only lose the $100. Some services manage your P2P lending account for a small commission. Something to consider if you just want to write the check and move on.

3. Wealth Management

If your windfall hits six figures or higher, a robo-advisor won’t cut it. You need information on managing the capital, investing it, and minimize tax liability. If you’re new to handling large sums of money, get an advisor before you do anything else.

Find a Financial Advisor

The type of financial advisor you want is a fiduciary. A fiduciary is legally bound to put their client’s welfare ahead of their own interests.  Fee-only financial planners are advisors who get paid solely by their clients. They don’t take commissions on the products or services they suggest or recommend.

Brokers who aren’t fiduciaries aren’t bound by the same principles. It doesn’t mean they are unethical. But they are only required to suggest “suitable” products or services. They may recommend products that earn them a commission. If you’re new to investing, a fiduciary is your best bet when a huge windfall hits.

Emerging Markets

You can balance your portfolio with investments in developing countries. These investments offer much much higher returns than U.S. or EU markets. An emerging market is broadly identified as a country with a unified currency and a stock market, working toward industrialization. Emerging markets are classified by the International Monetary Fund (IMF) and Morgan Stanley Capital International (MSCI.)

Mexico, India, Indonesia, and Chile would be examples of emerging markets. So are Russia, Pakistan, and Singapore. The investment returns are higher than US markets, but so is the risk. This interactive graph shows the performance of emerging markets from 2009 to 2020.

Under-developed countries can experience events that affect more than the market. Currency collapse, corruption in government, lax laws protecting investors. There is money to be made, but not perhaps for the faint of heart.

Include Tangible Assets

When most people think of investments, they think of stocks and bonds. But a diversified portfolio will include tangible assets like real estate, precious metals or art, and collectibles. Real Estate Investment Trusts (REITS) are very popular because of the tax breaks. Investors receive dividends quarterly and have ownership in multiple projects.

The stock market is very volatile, though over the long-term, the gains are consistent. When you invest in gold or collectible memorabilia, it balances your portfolio. Diversification and regular balancing are the best way to reduce risk and maximize returns in bull or bear markets.

Take Full Advantage of a Windfall

A windfall is found money that can change your life financially if you manage it properly. Don’t make quick decisions. Hire a professional – preferably a fiduciary – to talk you through what to do.

Once word gets out about the money – expect a lot of requests for help. Friends, family, total strangers are going to ask. Get some advice on how to help people you love and protect yourself from scams.

Lastly, don’t forget that charitable giving is a great tax deduction. You can pay your windfall forward.

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