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When most people think of a financial windfall, they think of winning the lotto. However, financial windfalls aren’t just some fairy tale. For most people, they’re a reality. Tax refunds, inheritances, and bonuses are all financial windfalls. That means most folks will experience at least one, if not more, in their lifetime. And when one hits, you need to be ready for it.
The challenge is, most people don’t prepare for a financial windfall. Instead, they squander any additional cash they receive on material possessions that don’t help to improve their future financial position.
Today, I want to help you change that. I’ll share everything you need to know about financial windfalls and the money moves you need to make when you’re lucky enough to receive a windfall. Let’s get started!
What is a Financial Windfall?
First, what is a financial windfall?
Simply put, it means receiving a sizeable amount of money outside of your regular income.
How Much Money Is Considered a Windfall?
While no defined amount of money qualifies as a windfall, it is any sum of money you did not expect to receive as part of your regular income.
For most people, it has to be enough money to make a difference financially. A good rule of thumb is anything over $1,000 can be considered a windfall.
Types of Financial Windfalls
Windfalls come in many shapes and sizes. Some of the most commons types include:
- Tax Refunds (or government stimulus money)
- Work-related Bonuses (signing bonuses, performance bonuses, etc.)
- Lottery Winnings (one can dream, right?)
Financial windfalls can be small, just a thousand dollars, or hundreds of thousands. It doesn’t much matter where the money comes from or the size of the windfall. The action plan I am going to layout for you is the same. It works for any amount of money and any financial situation.
Why You Need a Financial Windfall Plan
As you can see, lots of people will receive a financial windfall at some point in their lifetime, be it in the form of a tax refund or an inheritance.
And that’s why it pays to have a plan. Because when a financial windfall hits, the worst thing you can do is spend the money before you have a chance to consider using it to get ahead financially.
Many people end up spending even more than they receive from their windfall! So not only does the windfall not help their finances, but it makes them worse!
Used wisely, however, a financial windfall can give you a small “reset” button on your finances and create a unique opportunity to get ahead.
So, without further ado, let’s dive right into financial moves you should make when you receive a financial windfall.
What to Do with a Windfall
No matter your financial position, these nine steps will help you manage a financial windfall effectively as an agent of change for your finances.
1. Don’t Do Anything
The very first thing you should do when you receive a financial windfall is…nothing?
Yes, you heard me right.
The reason is there is tremendous temptation to make a lavish purchase either in anticipation of receiving a windfall or as soon as the money hits your bank account.
And when that happens, well, this is what happens next:
Christmas Vacation has one of the classic all-time moments when it comes to windfall expectations. The main character, Clark Griswold, plans on getting a bonus check, and before even receiving it, puts a deposit on a swimming pool.
However, he soon finds that he will not be receiving a bonus and goes, well, a little nuts.
My point is this:
1. Don’t pre-spend in anticipation of a windfall.
2. When you receive your windfall, take some time to come off the emotional high before you decide what to do with the money. It’s best to stick it in a safe place like a savings account until then.
3. Don’t spend your windfall on a swimming pool, unless it’s really, really, really important to you.
Once you’ve taken a little time to mull it over, get ready to build out a plan of action using your budget. Any budgeting tool will work, but my favorite is You Need a Budget (YNAB).
Over the next eight steps, we’re going to get very clear on your long-term financial goals so that you can put your windfall to the best use for YOU!
2. Plan for Taxes
Alright, while this maybe isn’t the first thing you wanted to use your financial windfall for, it is perhaps the most important.
When you receive a substantial amount of money outside of your regular income, you’ll want to think about the tax implications.
Tax implications apply to nearly all types of windfalls, and every situation is unique. That’s why I recommend you speak with your tax professional to set aside the amount you’ll owe Uncle Sam. Better to do it now than try to come up with the money later.
3. Pay Down Debt
Once you’ve set aside the requisite amount for taxes, the absolute best thing you can do is pay down high-interest-rate debt. For most people, this means credit card debt, but there are other types of debt, which can be expensive as well.
If the debt has an interest rate of more than 7-8%, pay it off.
Some people want to use a windfall to pay down a mortgage, but assuming you have a low-interest fixed-rate mortgage (in the 3-4% range), I’d rather you consider some of the next few options first and pay down your mortgage only if you have money left over.
4. Build Your Emergency fund
After you’ve paid down high-interest-rate debt, the next best thing you can do is grow your emergency fund.
Why? Because an emergency fund gives you a cash cushion should your financial situation take a turn for the worse. It is THE best way to build your financial fortress and protect yourself against unexpected shocks.
For most people, I recommend a six-month emergency fund, but if you have a variable income, you may want to consider something even longer. If you have just a month or two of emergency savings now, use your windfall as an opportunity to build that out!
Looking for the best place to keep your emergency fund? Check out why I like Series I savings bonds for this purpose.
5. Plan for Retirement
Next, if you’ve covered taxes, high-interest-rate debt, and your emergency fund, you’ve covered the most important things to do with your financial windfall.
You are now in a position to exercise a bit more flexibility with what you do with any remaining funds.
For many people, I suggest trying to max out retirement accounts. For most people, this means a 401(k) and an IRA.
Now, the IRA is relatively simple. You can contribute up to $6,000 per year to your traditional or Roth IRA as of 2022.
If your windfall came in the form of a work bonus, you could directly increase your Roth or traditional 401(k) contributions to max out your 401(k). But what if you received a different type of windfall? Is there still a way to take advantage of investing more in your 401(k)? YES!
Let’s assume it’s December, and you have only managed to contribute $15,000 to your 401(k) for the year. The contribution limit as of 2022 is $20,500. So, you’re $5,500 short of maxing out your 401(k) for the year. What can you do?
Let’s assume your windfall was at least $5,500, and your monthly income is $5,500. You can increase your 401(k) contribution to 100% for the month (i.e., don’t take a paycheck), max out your 401(k), and then use your financial windfall to cover your monthly expenses!
You’ve just found a way to max out your retirement for the year, giving you tax advantages you wouldn’t be able to receive directly through the windfall!
6. Start Sinking Funds
My next recommendation for a financial windfall is to set up sinking funds for any spending you anticipate in the future. Sinking funds are money that you track towards a future designated spending purpose.
Some potential sinking funds you can set up with your windfall include:
- Holiday spending
- Charitable giving
- Down payment on a home
- Home maintenance
- New car fund
- Car maintenance
- Wedding/honeymoon fund
You name it! Whatever your future spending plans are, setting aside dedicated funds can help reduce the stress when you do incur the expense.
Want to learn more about sinking funds? Check out my guide on What is a Sinking Fund and Why You Need Them!
7. Invest in Taxable Accounts or Alternative Assets
If you’re looking to set aside more money for your future self, another option is investing through taxable accounts or in alternative asset classes.
Want to learn how to invest a windfall in stocks and bonds? Spoiler alert. It’s not much different than investing any other sum of money. Here are some articles to help you get started:
If you’re considering alternative investment options, consider investing in real estate or peer-to-peer lending.
If you want to invest in real estate passively, check out Fundrise. It’s where I invest most of my money in real estate, and I have found the platform to be outstanding!
Fundrise is my favorite tool for getting started with real estate investing. It allows you to invest in a diversified portfolio of commercial real estate at low costs and with a great deal of transparency. Check out my full review to see if this tool is right for you!
Alternatively, you can consider investing in real estate directly through a platform like Roofstock or by doing it yourself. The book that got me started in real estate investing is The Book on Rental Property Investing. I have been on the search for my first rental property for the last few months, and this book gave me the confidence to know that I’m going about things in the right way.
8. Give Money to Charity
Of course, if you’ve taken care of your near-term obligations and have set yourself up for financial success, giving to charity is an excellent use of your windfall.
Everyone has a different plan for charitable giving, and that’s okay! But whatever it is, set aside a slice of your financial windfall to do some good for others!
9. Buy Yourself Something Nice
Finally, if you receive a financial windfall, it would be a mistake not to have any fun. While dealing with debt, investing for the long-run, and planning your financial future are all extremely important, if you don’t enjoy your windfall, you’ll feel deprived.
The key to long-term financial success is building in rewards along the way. So, set aside at least a small slice of your windfall to do something fun now! This could be traveling, a massage, good seats for a sporting event, or anything you can imagine!
Just remember that the immediate enjoyment purchase should be a fraction of the overall windfall. Use the windfall to create a longer-term financial fortress, and there will be a lot more fun to come!
Financial Windfalls: 9 Financial Moves to Make Immediately
Financial windfalls aren’t some far-out financial concept reserved just for lotto winners. No, they also apply to those who receive bonuses, tax refunds, and more.
So, when you get your first (or next) windfall, feel prepared in knowing that you’ve got a robust plan to make the most of it.
To quickly recap, here are the nine financial moves you should make when you receive a financial windfall.
- Don’t Do Anything
- Plan for Taxes
- Pay Down Debt
- Build Your Emergency Fund
- Plan for Retirement
- Start Sinking Funds
- Invest in Taxable Accounts or Alternative Investments
- Give Money to Charity
- Buy Yourself Something Nice
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