"What should I do if I receive a sudden financial windfall?" This is probably the question lingering in your mind if you are hoping to receive huge amounts of money. Or have you already received an unexpected lump sum?
Whichever is the case, the essence of windfall planning cannot be overemphasized — It’s critical. Stay put as we discuss the meaning of "financial windfall," the importance of having a plan in place, and what to do in the event of a sudden financial windfall.
What is a Sudden Financial Windfall?
A sudden financial windfall is a large financial gain that a person or an individual gets unexpectedly. It can come as an inheritance, legal settlement, lottery or gambling win, stock options payout, or a gift.
Importance of Having a Plan in Place
Although a windfall offers an opportunity for financial improvement, it can be challenging to manage your spending. But having a plan can help you maximize the benefits of a financial windfall, avoid impulsive decisions, and mitigate risks. You can plan for your windfall by:
Assessing Your Financial Situation
To assess your financial situation after you've received a financial windfall, you should:
Understand Your Current Financial Standing
Understanding your current financial standing can help you to know to use your windfall to change your financial situation for the better.
Identify Outstanding Debts or Financial Obligations
Identify outstanding debts or financial obligations. This will help you prioritize, especially when setting up a debt repayment plan.
Determine Short-term and Long-term Financial Goals
Do you have short-term financial goals like buying a car or building emergency fund?
Perhaps you have long-term financial goals such as retirement savings or education funds for your children. Whichever it is, identifying these goals will help you prioritize how to use the windfall.
Creating a Plan
After assessing your financial situation, create a plan. Here is how to do that.
Set Priorities for Your Financial Windfall
Look at your financial goals and decide if you'll prioritize debts, investments, or saving for the future. But if you have high-interest debts like credit card balances, consider settling them first as they can accrue significant interest over time.
Establish a Budget and Stick to it
Using your current spending, establish a budget that reflects your financial goals and stick to it. This will help you in spending wisely. Start by listing your expenses, including fixed expenses like rent or mortgage payments and variable expenses like groceries and entertainment.
Decide How to Allocate the Funds
Decide how to allocate the funds to investing, savings, and spending. You can use the 50/30/20 rule after tax deductions. Generally, the rule is 50% for needs, 30% for savings, and 20% for spending.
Research Charities and Tax Benefits
You can minimize tax liability and enjoy your financial windfall by donating to charity. This is because most charity organizations have tax-exempt status with the Internal Revenue Service (IRS).
Consider Tax Implications
The tax implications of windfalls depend on the source of the funds. For instance, a windfall that comes from an inheritance or gift may be subject to gift or estate tax. But if the windfall comes from an investment, you may owe capital gains tax on any profits.
By considering the tax implications of your windfall, you'll avoid any unwanted surprises come tax day.
Investing Your Windfall
After creating a plan, you can invest in your windfall. But before you do:
Understand the Different Investment Options
There are different investment options like stocks, bonds, or real estate investing. Understand these different options and consider how much risk you're willing to take.
Diversify Your Portfolio
Diversify your portfolio to minimize risk and increase potential returns. Also, buy into investments that are tax efficient, like 401(k)s, because they're designed to minimize taxes. Consider balancing asset allocation by adding the appropriate mix of assets in your investment portfolio. This mix can be based on your investment objectives, risk tolerance, and investment horizon.
Consider Working with a Financial Advisor
A financial advisor can help you with financial planning like wealth management, risk management, or investment management. They can also recommend investment strategies to help you achieve your financial goals.
Saving Your Windfall
Aside from investing your windfall, you can also save. Here are the steps to take.
Explore Different Savings Options
You can check out savings options like high-yield savings accounts, certificates of deposit (CDs), or investment accounts. Also, review and compare interest rates to ensure that you're getting the best offer.
Maximize Your Retirement Savings
Have a retirement savings plan and start on time. You can also maximize your retirement savings by contributing to tax-advantaged retirement accounts or adding catch-up contributions to your account and automating these contributions.
Consider Other Long-term Savings Goals
Consider other long-term savings goals like college savings, emergency funds, or paying off debts. Doing this can help you allocate an appropriate amount and save consistently to meet your goals.
Spending Your Windfall
You can spend your windfall, but you should have some to fall back on in the future. You can do this by:
Budgeting for Discretionary Spending
Budgeting for discretionary spending can help you adopt wise spending habits that can help your finances. Also, make sure that your budget reflects your lifestyle and priorities.
Making Wise Purchasing Decisions
Be mindful of your spending and avoid making impulsive purchases. Write out your needs, have a budget, and strike out the needs that can wait. These will help you make better purchasing decisions.