If you recently received a lump sum of money through an inheritance or any other reason, congratulations. You’re in a wonderful financial position.
But what should you do with that unexpected cash?
In this article, I’ll help you figure out how to make the most of your windfall based on your current financial situation.
- When Would I Get a Lump Sum?
- Take Your Time Before Making a Decision
- Consider Your Tax Implications
- Don’t Be Afraid To Consult a Professional
- Can I Spend My Windfall on Anything Fun?
- Thinking About Saving and Investing the Clark Howard Way
- Invest It All Now or Invest Over Time?
When Would I Get a Lump Sum?
If you recently came into a stack of cash, you know where it came from. If you’re just dreaming about it, your dream may have featured a fairy godmother. In real life, here are the typical scenarios that lead to sudden lump sums:
- Bonus at work
- Selling a business
- Insurance or legal settlement
- Lottery check
- Tax refund
So now you have some financial decisions to make.
Take Your Time Before Making a Decision
It’s natural to feel a wave of emotions when you receive a cash windfall.
That would be true if you suddenly hit a jackpot at a casino or discovered a bag full of cash in your closet. But in many instances, the thing that leads to you receiving money is already a big, emotional life event.
It’s also natural to start thinking of the things the money makes possible including vacations and possessions. It’s exciting to get a large lump sum of money, and it’s OK to be happy!
But there’s no rush to spend, save, invest or give with your windfall. In fact, it’s a good idea to take a deep breath before you do anything at all. Your first goal is to preserve the money. You should think through your options and priorities to make sure you’re making a solid long-term decision.
If you’re receiving an inheritance, that’s going to become public record in many states. You may start getting a flurry of solicitations from insurance and investment salespeople as well as would-be entrepreneurs offering you a chance to “get in on the ground floor.”
“It’s a time that I want people to be ultra, ultra conservative with the money until they come up with a plan,” Clark says. “My experience has been that people who come into a large amount of money — it’s so foreign to them that they often will make hasty and risky decisions with it.”
Clark recommends stashing every dollar in a savings account to start with and talking to a financial advisor before you make any other decisions
If you’re worried about sitting on your cash and not getting anything in return, consider putting it in a money market account or in a short-term bond index fund.
Consider Your Tax Implications
Depending on how you got your lump sum and where you live, you could owe taxes on it.
For instance, as of February 2021, six states impose an inheritance tax. In Nebraska, you could be required to pay as much as 18%!
Consult with a tax professional if you need to do so. But figure out whether you owe taxes on your windfall so that you can set aside money to pay them. You don’t want to spend that money or put it into an illiquid investment.
It also may be a good time to consider lowering your tax liability through charitable giving.
Don’t Be Afraid To Consult a Professional
If you get a $1,000 tax refund, you probably don’t want to spend $300 on a one-time consultation with a Certified Financial Planner (CFP).
There’s likely no advice he or she can give that will overcome an immediate ROI of -30%.
However, if you receive a $200,000 legal settlement, it’s worth paying a few hundred dollars to get input from a legal fiduciary. You could also consider hiring a financial advisor to help you create a comprehensive financial plan.
Clark puts it this way: “What is your overall goal for your life? And what’s it going to take to get there? Because real financial planning is looking at things from a goal standpoint, a tax standpoint and a personal standpoint.”
As I mentioned earlier, perhaps you need a tax expert to help figure out what portion of your lump sum you’ll owe to the government. And maybe you want to invest enough money from your windfall to retire one year earlier while giving the rest to charity. A good CFP could help you figure out the correct allocations for all of this.
If you came by your windfall through an inheritance, the good financial news could be tempered by a good deal of stress and emotion. That’s not the best time to make big decisions, so consulting outside financial counsel could be a good idea.
If you are considering a long-term relationship with a financial planner, Clark’s first recommendation is Vanguard’s Personal Advisor Services. It gives you unlimited access to a CFP who is personally assigned to your account. You’ll pay an annual fee of 0.30% or less, and they’ll use Vanguard’s robo-advisor to invest your money.
Personal Advisor Services does require an initial investment of $50,000.
Can I Spend My Windfall on Anything Fun?
Great news: Clark wants you to take 10% of your lump sum and spend it however you want.
“If somebody has a pile of unexpected money, they say, ‘Well I’m not going to spend any of it.’ But then they’ll say, ‘Well, I’d like to do this,’ and then ‘I’d like to do that,’ and then ‘I’d like to do this other thing,'” Clark says. “Before you know it, the money starts shrinking right before their eyes.
“That’s why 10% of the money is your mad money.”
Use the 10% to go on the vacation of a lifetime, buy the newest Corvette or invest in your friend’s dog toy startup if that’s what you want to do.
Clark compares this to going on a diet. If you never have a “cheat day” or some way to reward yourself occasionally, you’ll probably backslide eventually — sometimes with disastrous consequences.
So yes, you’re allowed to have some fun with the “found” money.
Thinking About Saving and Investing the Clark Howard Way
This is a great time to assess your overall financial health.
Do you have debts? Do you have an emergency fund? Those are great places to start putting your money if you haven’t ticked those boxes already.
The next step is to prioritize investing for retirement.
Pay Your Non-Mortgage Debts
It may not sound sexy. But paying off debt, especially high-interest credit card debt, can be one of the best financial decisions you ever make.
Build Your Emergency Fund
Clark recommends putting up to six months of household expenses into an emergency fund.
Interest rates are at historic lows, so Clark also has some advice on alternative places to stash your emergency fund.
Take Full Advantage of Your Company 401(k) Match
Many companies are willing to match your 401(k) contributions up to a certain amount.
If you aren’t already doing so, take advantage of the cushion your new lump sum of money may provide. Increase your 401(k) contributions to get the maximum company match.
Start an IRA
If you don’t have access to a company 401(k), or you’re already maxing out your contributions, consider opening an IRA.
Invest It All Now or Invest Over Time?
So you’ve decided to invest a substantial portion of your inheritance or windfall. Should you put it all into the market immediately or invest it more slowly?
Conventional wisdom says time in the market benefits you more than trying to time the market. In other words, the math says you should invest it all now.
Clark doesn’t agree.
“I’m a real believer in behavioral economics. How people react emotionally is as important, if not more important, than the practical,” Clark says.
“If you’re not used to having a large sum of money, you put it all in the market and the market takes a dive, that’s really, really hard for you. Where if you invest it over, let’s say, a few years, the psychological issues are not as present.”
Financial decisions can be stressful because they can make a big impact on your life. But if you’ve recently come into some money, that’s a good thing.
The fact that you’re reading this article shows that you’re being thoughtful about the best way to handle your windfall. So you’re already on the right track.
Although the amount of money is likely more than you’re used to getting at one time, if you already manage your money well, your strategy shouldn’t differ all that much from the way you save and invest your normal income stream.