What to Do With an Unexpected Windfall

Find yourself with a lot of unexpected money? Here are some tips on what to do with it.

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We have all fantasized about winning millions in the lottery. However, people rarely figure out how they are going to manage sudden wealth. Lottery winners are more likely to declare bankruptcy just one to five years later than the average American. 

Because most windfalls are unexpected, people don’t feel the need to adequately prepare for them. But not all surprise windfalls are multi-million dollar lottery payouts. Surprise windfalls can also come from inheritances or lawsuits. 

While likely not in the tens of millions, even an inheritance of $100,000 can have a significant impact and, if managed properly, may even be life-changing. That's why it is so important to plan ahead. 

What Is a Windfall?

Generally speaking, a financial windfall is any unexpected, large amount of money you might receive. This makes for a pretty broad category.  We brought up two notable examples with lotteries and inheritance, but there are many ways in which you may find yourself enjoying a windfall over the course of your life. 

Roughly all windfalls into two buckets: Either something very good or something very unfortunate happened to you. 

  • On the positive side, it could be the classic example of winning the lottery or getting a cut from a successful deal at work.
  • Other reasons could be finding a buyer for something you never considered you could sell, such as an antique or a collection.
  • Windfalls can also come as a result of less fortunate circumstances, such as an inheritance from a close loved one who has passed away, or the result of a lawsuit settlement. 

What separates financial windfalls from typical work bonuses is that they come as a surprise and are generally large in comparison to your current income. These two factors can have large consequences on whoever has received the windfall. 

How to Manage Sudden Wealth

Coming into sudden wealth sounds like an absolute blessing, but as the saying goes, there are no free lunches. Many of the costs of sudden windfalls are intangible and unrelated to money, but rather things that impact your relationships and your own mental health. We believe this is a crucially underlooked element that can lead to disaster in certain cases; the best way to prepare for these tensions is to be aware.

1. Be Aware of Your Psychology 

work with your tenantsWe never know how a sudden windfall can affect someone psychologically, as dozens of factors may determine a reaction to new wealth. Some people may not fully value what a gift a windfall is, and look to spend it lavishly. Others may look to spread that wealth amongst friends and family, often without thinking about keeping any for themselves. Another common reaction may be paranoia. 

It's impossible to accurately predict how someone may act with so many factors coming into play — including familial ties, income bracket, upbringing, and more. One piece of universal advice we can offer is to be aware of any changes in your own personality and remind yourself to stay grounded. A good general rule of thumb is to think how you would act if you hadn’t received any sort of windfall, and continue to act accordingly 

2. Keep Your Day Job

women at workA common pitfall when coming into a surprise windfall is that people immediately quit their jobs. They assume their life has changed forever and that the windfall will be able to easily maintain their current lifestyle in perpetuity. This kind of short-term thinking can have serious consequences when you find out that this is not the case. 

Many feel a sense of freedom upon coming into a surprise amount of money, but going back to our first tip — the best advice is to not change your lifestyle. You should always consider your job as your bedrock and a stable income. If you try to replace your income with the one-time payout you received, you run the risk of using it all up prematurely, rather than allowing the windfall to grow and benefit you for the long term. 

3. Beware of Lifestyle Creep

Lifestyle creep, or keeping up with the Joneses syndrome, is when someone, consciously or unconsciously, feels the need to pay for more and more expensive lifestyles as their income grows. This person likely sees other people living extravagantly and feels the need to match up. 

This idea is dangerous on so many levels, and comparing your current situation to others is a game that simply doesn’t end. If you surpass the lifestyle of whoever you envy, you will simply move on to the next neighbor that makes you jealous. This reinforces a cycle where you keep buying more and more expensive things and enjoy none of it.

The next issue with lifestyle creep is that, despite your lifestyle appearing more lavish, your actual worth remains the same or even decreases. While your income increases, your expenses increase at the same rate, technically leaving you in the same state you were in before in terms of savings. In the worst-case scenario, your newfound expenses actually exceed your income. 

The final issue with lifestyle creep and windfalls is that they are not an income that has grown, but rather a large one-time payment. If you are creative enough, you can easily find ways to spend your entire windfall on lifestyle upgrades and then be left without a way to maintain that lifestyle. What likely follows is the painful process of also degrading your newfound lifestyle. 

4. Talk to Your Friends and Family

FamilyWhile everyone’s situation is different, for both your and your close one’s benefit, it is best to have a frank and open conversation about your windfall. You should never feel ashamed to draw red lines when it comes to your own money. Those close to you will appreciate the openness and will also feel comfortable if they need to ask you for something. 

Remember, even if it is awkward to have that discussion ahead of time, it's better to be proactive than to feel cornered in an uncomfortable situation. 

5. Determine Your Tax Implications 

Another thing people most often forget about is taxes. Almost all windfalls will be taxed and the rate can vary significantly based on where you are and the kind of windfall it is. When planning how to spend or save your windfall, you should always look at the after-tax number for a more honest representation of what you will have to work with. 

A windfall may bump you up into a higher tax bracket. This can have far-reaching consequences on your life, including on things completely unrelated to the windfall, and as is an important consideration.

For any tax advice, you should consider speaking to a professional, just as any questions about managing your windfall can be answered by a financial advisor like those found through the  Paladin Registry. A financial advisor can devise a plan that suits your needs with how to make use of your financial windfall. 

What to Do With a Windfall of Money

So what should you actually do with a windfall of money? The order of importance for the recommendations below will change from person to person. Someone carrying high-interest debt on three credit cards and someone who is debt-free will obviously have different needs. 

Pay Off Your Debt

Payoff DebtThis one can get tricky as there are so many kinds of debt out there, and some are worse than others. 

One type of debt that we can universally agree on that needs to be paid off right away is high-interest debt. This can be a payday loan or credit card debt, which frequently add up to annual percentage rates (APY) in excess of 20%, and for those with poor credit, can jump much higher. 

There really is no good reason to hold onto this kind of debt, so a top priority should be getting rid of it ASAP.

Create an Emergency Fund

emergency fundOnce you no longer have any high-interest debt, you should consider creating an emergency fund. This should be something liquid, which means either putting it in a separate checking out or savings account. You won’t be looking to earn interest on this, but instead, it should give you peace of mind in case tragedy strikes. Your emergency fund should act as a safety net and can also give you confidence in taking more career risk — for example, moving to a new location for a potentially better job.

How much you should have in your emergency fund is up for debate. The standard thinking is to have anywhere between three to six months of expenses. This allows you a good enough buffer to get back on your feet in case of the worst. You can also start with three months, and slowly add on to it monthly until you reach six months of expenses. There isn’t any reason to get excessive and save over this amount, though. 

Set Aside a Small Portion for Fun

Elimination of File and Suspend Couples Social Security Claiming StrategyWhile maybe non-traditional financial advice, we do believe that life shouldn't be about saving every last penny and doing nothing with it. If you have taken care of your debts and saved some money on the side, you should be allowed to enjoy some of the windfall. Remember, however, to always spend within your means as if you never had the windfall in the first place. This thinking will keep you grounded and not go over the top on a spending spree. 

Invest Your Money

The next stages are all about taking your surprise windfall and turning it into something that will potentially last generations. The key to that is investing. 

There is a reason that Albert Einstein considered compound interest the eighth wonder of the world — even just $10,000 invested at 12% a year over 25 years comes out to $170,000. If you decide to add $100 a month over that 25 years on top of the $10,000, that amount adds up to $338,621! 

What you decide to invest your money in is a wholly personal choice and should be a critical step you discuss with your financial advisor, but for long-term investing where you won't touch your investment, there are few strategies that outperform a simple index fund. 

If you want extra motivation to start investing, consider inflation

Source: SmartAsset

Every year that you leave your money sitting around collecting dust, it is actually losing value. Much like investing, that loss also compounds over the years. The only way to counteract the impact of inflation is by at the very least earning interest in excess of the inflation rate. Bonds used to perform that role, but in a world of near 0% interest rates, that is becoming exceedingly difficult, leaving stocks as the most obvious alternative. 

Find out more >>>

Pay Off or Consider Buying a Home

Pay MortgagesNotice how we didn’t include mortgages in our debt category? That's because mortgage rates are relatively low and as you pay them off you increase your equity in the home. That is why this step is lower on the priority list as it really is a luxury to be able to pay for your home in one go. If that luxury is available to you, you may want to consider it for the extra peace of mind, as well as freeing up the money that would have gone to your mortgage payments and interest. 

Create or Update Your Estate Plan

This one is highly dependent on how large your windfall is and your personal situation (whether you have kids, or are single without children). What to do with $100K and $1 million are two very different questions. 

If your windfall is large, and you already have a family, estate planning is essential for making sure that the windfall gets passed down to your heirs in a fair and smooth way. This, however, should be advised by a professional like Trust & Will, where you can create trusts, wills and other legal documents for a reasonable rate. 

With Great Power Comes Great Responsibility 

We don’t mean to burst the bubble of all the fun of coming into a surprising amount of money, but we sincerely believe that there are too many pitfalls to windfalls that no one talks about. It’s better to protect yourself and enjoy your windfall over the long term rather than just enjoy it for a fleeting moment. 

Isaac Aydelman

Isaac Aydelman is a student of economics and a former soldier. Drawn to financial markets from an early age, he has experience in futures trading and manages his own personal investment account. Isaac is always interested in expanding his horizons and looking out for opportunities in finance.

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