We’ve all heard the joke where a person meets a genie and says, “I wish I was richer!” and the wish is granted in some way that goes comically wrong. While we can laugh and relate to the annoyance of bureaucratic loopholes or ironic syntax, the truth is that it’s often difficult to know how to manage windfall money.
Luckily, being Smart About Money™ is often as simple as knowing the facts, having a plan, and sticking with it. With that in mind, here are some tips on how to handle unexpected income and what to avoid.
How to Be Smart About a Bonus
It’s always exciting to receive a holiday bonus, a promotion, or an increased paycheck due to a job transition. While there’s nothing wrong with celebrating your good fortune or the well-deserved results of hard work, strategic thinking can help an influx of cash have a greater impact.
Don’t:
Avoid the temptation to give in to lifestyle creep. Upgrading your home, vehicle, and “fun” budget will buy you a good time now at the cost of reaching your big-picture goals sooner.
Do:
Instead, keep your budget the same and direct surplus income toward long-term goals.
- Shore up your emergency fund and personal escrow account. While these savings don’t directly go toward long-term financial goals, having adequate funds set aside means you won’t have to pull from your retirement savings in an emergency. At a 10% early withdrawal tax penalty, not to mention the lost growth potential to your account, you don’t want to be forced to touch those funds until retirement.
- Pay off any debt. Once your emergency reserves are funded, redirect the surplus toward paying off credit card debt, student loans, a vehicle lease, or your mortgage. You can prioritize the lowest-interest loans to gain momentum (the snowball method) or the highest-interest loans to pay less interest over time (the avalanche method). Select the option that is more motivating to you, and learn more about it here.
- Increase your retirement contributions. If you aren’t hitting the maximum limit for your annual retirement contributions, use your excess income to do so! Starting early and staying consistent are two of the most important things you can do to help your retirement savings benefit from compounding. If your employer offers a 401(k) match, prioritize contributing up to the match limit so you can take advantage of free retirement savings. Even if you can’t hit the maximum yet, try to increase your contributions each year.
How to Be Smart About Lottery Winnings
Very few of us will ever win the lottery, but whether or not you happen to be a lucky winner, these savings principles will help you know how to manage windfall money.
Don’t:
A spending spree might make some good memories, but it’s too easy to let a valuable financial opportunity slip through your fingers.
Do:
There are three people you need to call or hire as soon as you receive a windfall: a financial advisor, a tax planning professional, and a lawyer.
- Create a tax strategy. If you win a sizeable amount, pushing you into a higher tax bracket, you’ll owe the difference on top of the 24% that most lottery agencies withhold. A tax planner can help minimize your tax liabilities through strategies like gifting funds or estate planning.
- Think about your legacy. Working with a financial advisor can help you put your money where it will generate manageable taxes and have the biggest impact, all while aligning with your values and goals. They can help you create a plan for charitable giving, maximize your retirement accounts, plan for long-term care coverage, and more.
- Navigate the legalities. Significant wealth comes with its complexities, especially when planning to leave it to family members. You’ll need to enlist a good family lawyer to help you protect your assets, establish a trust, update your will, and so on.
How to Be Smart About an Inheritance
An inheritance can come in many different forms. You may receive cash or cash assets like a CD or death benefit from a life insurance policy, invested assets like stocks, bonds, mutual funds, or a retirement account, or physical assets like a house. While each type of inheritance requires its own approach, here are some general guidelines.
Don’t:
One of the most common mistakes people make after receiving an inheritance is losing it due to mismanagement. Studies have shown that 70% of generational wealth is lost after passing to the 2nd generation. But did you know that leaving an inheritance untouched can often contribute to its decline in benefit?
Do:
You can maximize the value of an inheritance by managing it wisely and involving the help of a financial advisor.
- Invest cash and cash equivalents. If you inherit liquid assets like cash, a money market account, a CD, or a death benefit from a life insurance policy, it’s important to factor inflation into your plans. Leaving those assets uninvested means there’s a good chance they’ll lose their buying power as inflation rises. Instead, talk to your advisor about investment strategies that allow the funds to grow along with inflation.
- Sell depreciating assets. Some physical assets may be valuable for sentimental reasons and worth keeping. However, if you don’t plan to keep them, it’s a good idea to sell them before they lose value or incur costs for upkeep. Assets like a house, RV, boat, or vehicle all require regular maintenance and depreciate over time, making it wise to consider selling sooner rather than later.
- Honor your loved one’s memory. Not everything of value can be measured in dollars. You can make an inheritance more meaningful by using it to give to a charity that your loved one supported, making a major purchase or investment aligned with your goals, or using it for something you wouldn’t otherwise be able to afford, like long-term care insurance. For more insights specific to inherited IRAs, click here.
Stretch Your Windfall, Not Your Budget
Unfortunately, it’s all too common to let a sudden increase in wealth get absorbed into everyday bills or splurge purchases. We want you to be Smart About Money™ so you can maximize your good fortune or the gift of a loved one by reaching your goals and leaving your own lasting impact. If you’ve come into a lump sum or are planning to leave one to your beneficiaries, reach out today to learn how we can help you plan smarter.
Any opinions are those of Traci Richmond and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Past performance is not indicative of future results.