Receiving a sudden and sizable influx of cash may seem like a dream come true. It can be, but many people get carried away and end up in worse financial shape. If you’re hit with a financial windfall, here are some points you should know.
Risky Conditions
You may be tempted to almost immediately make an expensive purchase, such as a luxury car or a vacation home. And friends and family members may expect to share in your bounty, or they may pitch “sure-fire” investment opportunities. Fraudulent charities may also come knocking.
You can avoid these potential pitfalls by stashing your windfall in a bank or money market account as soon as you receive it. Let it sit there until you’ve had some time to think carefully about how to best use the money and you’ve obtained advice from a qualified professional. Waiting at least a month before you touch the money can help prevent impulse buys and other mistakes.
Also, you may owe taxes. Some windfalls, such as lottery winnings and certain legal settlements, are subject to federal tax — as much as 37% federal tax if your windfall pushes you into the top income tax bracket. State and local taxes may apply as well. A tax professional can help you determine what you owe.
Shelter From the Storm
What you eventually decide to do with your windfall will depend on many factors. If you have debt, you’ll probably want to pay it off — especially if it carries a high interest rate and the interest isn’t deductible. Also, establishing or boosting your emergency savings can minimize the need to incur future debt.
Next, consider where you’d like to be five, 10 or 20 years into the future. Develop a plan that will help you move toward your goals — whether that means starting a business, retiring early, or something else. You probably shouldn’t quit your job without having thought it through carefully. Few windfalls are large enough to see you all the way through retirement (depending on your age).Only after those considerations should you contemplate making any major purchases. If using some of the windfall to buy that new car or vacation home now won’t interfere with your financial security and long-term goals, then go for it!
Long-Term Plan
To put a windfall to optimal use, a long-term plan is critical. Consult a tax or financial advisor for help assessing the tax and other financial implications of your windfall.
