What To Do With a Windfall
Most people think of winning the lottery, but windfalls come in many forms, including ones with much higher odds. Sure, you might win a contest, but you’re more likely to get an insurance payout, win a settlement, or inherit assets from a loved one’s estate at some point in your life. Whether it’s for $1,000 or life-changing millions, here are some considerations to make if you receive an unexpected sum of money.
Call for Backup
First, are you comfortable making this decision? Do you need help? These might seem like odd questions to ask at first, but there are a lot of factors that can make suddenly coming into money an emotional ordeal. Winning a large amount can be incredibly exciting, but that same large amount might be intimidating. Inheriting assets from an estate can bring relief in a financial sense, but likely would also bring some very difficult emotions from the loss of a loved one.
If you’ve come into money and are feeling particularly emotional, it may be a good time to consider speaking to an unbiased financial advisor or lawyer to help walk you through your options and potential tax implications.
The Time Value of Money
In short, layperson speak, the Time Value of Money is a financial principle stating that money today is worth more than the same dollar amount in the future. This is one reason why lottery winners almost always take the “lump sum” option instead of getting paid out in installments over time. Essentially, taking money now vs. at a later date:
- Ensures that you actually receive the money,
- Gives you the opportunity to invest immediately, and
- Avoids any decrease in purchasing power due to increasing inflation.
Still, if it’s an available option, you might find that receiving your money in installments is the right choice for you. Payouts in the form of annuity payments might be a better fit depending on your money personality or if you want a secure, continuous stream of income.
Pay Off Debt or Invest?
It might seem like an easy call to pay off your debts first, but take a minute to think it over first. If you’re planning to invest some of your newfound money, you might be able to get more bang for your buck by putting your money in high-yield investments. On the other hand, if you have debts with high interest rates, like a fairly-recent mortgage, credit card debt, or student loans, it may be a good idea to pay those off by targeting the ones that are costing you the most in interest. This only works if your investments have a higher return rate than what you’d save paying off your debts, so choose carefully!
Planning for the Future
If you’re hoping to leave some of your assets to your children, you could always just write it in your will and hope for the best, but there are other options available to you.
529 plans
529 plans are a specific type of savings account that can be used to pay for education costs, including private grade school, college, trade schools, and apprenticeships. These are state-sponsored tax-deferred accounts, and if the funds are used on qualifying educational expenses, then they are exempt from both federal and state taxes. If the beneficiary chooses to not use the funds for a qualifying purchase, you may even be able to use the funds for yourself! Specifics and benefits of these accounts vary from state to state, so check both your state and your beneficiary’s state of residence to find the one that fits your needs best.
Trusts
Trusts are a type of account that are used in estate planning in which the trust acts as an entity that maintains custody of assets on behalf of another person, managed by a third party called a “trustee.” Many people think that trusts are only for the super-wealthy, but that’s absolutely not true. There are some fees required to set one up, but generally there’s no minimum initial deposit amount. These types of accounts offer some tax advantages and avoids the complicated probate court process.
Other Vehicles
You can also leave money to family directly in cash while you’re alive (be mindful that there’s a maximum amount you can gift each year tax-free), leave it in your will, give savings bonds as gifts, or designate them as beneficiaries of your retirement accounts. You can even open an IRA in a minor’s name and start funding it yourself. As with everything else, you might want to talk to a financial advisor or lawyer to work through the details of your situation.
Regardless of how much money you’ve stumbled upon, take a minute to collect your thoughts before taking any action. Call in support if you need a professional’s expertise to navigate taxes and legal documents. Don’t buy anything big, especially anything extravagant, without a well-thought-out plan. Think through these considerations and you’ll be well on your way.
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