5 Tips for Handling a Financial Windfall

Everyone dreams of being on the receiving end of an unexpected cash payout. However, landing a financial windfall can quickly become a nightmare. Without some careful planning, you could squander the money before you’ve had a chance to put it to good use. Whether you’ve come into an inheritance, gotten a hefty bonus at work or hit it big playing the lottery, we’ve got some tips to help you make the most of your new-found wealth.

A financial advisor can help you decide how best to spend, save, and invest.

Initiate a Spending Freeze

If you’re like most people, after you cash your windfall check you’ll want to go on a shopping spree. That’s actually the number one mistake you should avoid. Instead of buying cars and vacations, do the sensible but boring thing and park the money. Stash it someplace safe, like a savings account. Give yourself some time to think about what you really want to accomplish with it.

Take a few weeks or even a few months to consider what your short- and long-term financial goals are. For example, you may want to pay for your child’s college education but have thousands in high-interest debt. You need to have a clear idea of your financial priorities. Then you’ll know how far the windfall will go towards helping you reach your goals.

Bulk Up Your Emergency Fund

If you don’t have any savings at all, a windfall is a perfect opportunity to beef up your emergency fund. Longfellow once said that “into each life some rain must fall.” ¹ You want to make sure you have a sizable financial umbrella in place when the monsoon hits. Using a windfall to grow your emergency fund gives you a little insurance against the unexpected.

Financial experts vary with regard to how much of an emergency fund you need. Some argue that three months’ worth of expenses is enough while others advocate six to eight months of savings. Ultimately, the size of your emergency fund depends on several factors. These include your monthly expenses, income, your overall job stability and family size. When deciding where to stash your cash look for a savings account with a good interest rate and low fees.

Dump High-Interest Debt

Some debts are better than others. If you’re mired in credit card bills, using your windfall to pay them off may be your best bet. When you pay a lot of money in interest each month to the credit card company it can easily outweigh the return you’d get by putting all the new money in a regular savings account.

If your windfall isn’t large enough to pay off all your debts consider paying off the highest interest rates. Set aside some of what’s left in your emergency fund. If you use the windfall to pay off all your debts but have no savings, you could end up right back in debt if you have to borrow money to cover an unexpected expense.

Plan for the Future

If you’ve been procrastinating about saving for retirement, then a windfall is the perfect opportunity. A traditional or Roth IRA is an excellent way to supplement your employer’s retirement plan. If your job doesn’t offer a 401(k) or similar plan then its a sign to start saving.

If you’re already on track with your retirement savings? Use the windfall to safeguard your financial future in other ways. For example, you could pay off your mortgage, try your hand at investing or start a business. Just make sure that you weigh any potential pros and cons before making any significant money moves.

Give Wisely

Once you settle your finances, you may feel an urge to share a little of your good fortune with others. Before you start handing out financial gifts, think carefully about who you want to give the money to and how they will use it. You also need to think about any potential financial consequences. For example, if you want to give your kids money to buy a house or pay for college, you need to be aware of the tax liability.

If you want to support a charity, take some time to research organizations to make sure they align with your beliefs. It’s also a good idea to make sure they’re legit before sending them a check. The IRS offers a free online tool that lets you check tax information for qualifying charities. If you do make a large charitable donation, don’t forget to get a receipt for tax purposes.

The key to making a windfall last is to take it slow and carefully consider all your options. Once you’ve got a plan, you can start putting your money to work for you, instead of the other way around.

How Your Windfall Is Taxed

Before you decide what to do with a windfall, it helps to understand how much of it you’ll actually keep, since the tax treatment varies significantly depending on where the money came from.

The IRS taxes lottery winnings as ordinary income at the federal level, and a large jackpot will typically push you into the top tax bracket right away. Lottery agencies must withhold a percentage upfront, usually around 24%, but that withholding often falls short of what you’ll actually owe for the year. Most states tax lottery winnings too, adding another layer on top of the federal bill.

Work bonuses fall under a different set of rules. Employers typically withhold a flat 22% for federal taxes on supplemental wages like bonuses, along with standard Social Security and Medicare taxes. That flat withholding rate doesn’t necessarily match your actual tax liability, though. Depending on your total income for the year, you could end up owing more, or getting some of it back as a refund.

Inheritances work differently still. There’s no federal inheritance tax, and the IRS generally doesn’t consider money you inherit as taxable income. But this can get more complicated depending on what you’ve inherited. An inherited traditional IRA, for example, doesn’t trigger immediate tax. However, the IRS will tax withdrawals from it as ordinary income down the road. This creates a future tax obligation that a lottery check or work bonus simply doesn’t have.

Because these windfalls carry such different tax profiles, “park it and think it over” means something different for each. Money that’s already been taxed and withheld allows for straightforward planning. An inheritance that comes with future tax consequences attached does not.

Get Professional Guidance Before Deciding

A spending freeze gives you time to think, but this has limits. Especially once the advice moves toward IRAs, mortgage payoffs, investing, or charitable giving. All of there carry their own tax and legal implications where timing matters.

A financial advisor can help you understand how your specific windfall fits into your broader financial picture. This includes how much of it is actually available to spend once you account for taxes. A tax professional, meanwhile, can help you avoid surprises, particularly with a lottery win or inherited retirement account. Those tax bills can be considerably larger or more complicated than they first appear.

Bringing in this kind of guidance during your pause, rather than after you’ve already started spending or investing, gives you a much clearer picture of what your windfall can realistically accomplish.

Bottom Line

A financial windfall, whether it’s an inheritance, a bonus, or a lottery win, comes with real opportunity, but also real risk if it’s handled carelessly. Slowing down before making any big decisions, understanding how your specific windfall is taxed, and building up savings or paying down high-interest debt are all solid first steps. Bringing in a financial advisor or tax professional during that pause, rather than waiting until after money has already been spent or moved, can help make sure your windfall does what you actually want it to do, instead of disappearing before you’ve had the chance to put it to good use.

Tips for Managing Your Money

• A financial advisor will help you with taxes and with other financial questions. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you have complicated finances you might need a CPA. If you have very complicated finances, you might need a tax attorney. Read on to learn all about the difference.

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