What to Do with an Inheritance or Other Windfall

One of the most critical moments in personal finance is the windfall. If you receive a large sum of money — from an inheritance, settlement, gift, winnings, or savings simply piling up — what do you do with it?

Do you …

• Buy the house or sports car of your dreams?
• Pay off debt?
• Invest in your future?
• Treat yourself to something special and save the rest?
• Use the money to live on so you never have to work again?

Even if you’ve saved or invested before, making the most of a large sum can be daunting … and it’s often emotionally difficult to deal with. This can be especially true for those who receive windfalls due to themselves or a loved one becoming injured or a loved one’s death.

We’ve all heard some windfall horror stories about those who have recklessly spent large sums of money quickly, even ending up in debt after it was all gone. Unfortunately, we don’t hear enough about the success stories, the wins of being financially fortunate, and parlaying that fortune into a more than comfortable financial future. It’s simpler than you may think. And while it requires some discipline both initially and indefinitely, the rewards are totally worth the effort. Whether you’ve received or saved an unexpected sum of money, here are some steps to make the most of it.

1. Pause to process and plan.

While windfalls are often self-explanatory, having a significant amount of savings sitting around is a different story. In either case, take a beat. Depending on your circumstances, the psychological side of receiving or discovering a windfall can be difficult. Take the time you need to process the non-financial side as well.

Then, it’s time to decide what to do with your windfall. And that depends on when you plan to use it. But first …

2. Keep it safe.

What does “safe” mean, exactly? It depends, at least in part, on the amount of money you’ve received and how you’ve received it.

If you’re looking at a cash windfall of $250,000 or less, you can store it at your local FDIC-insured bank or NCUSIF-insured credit union. These insurance types are important if you’re considering depositing your funds at such an institution. They show that the institution offers government-backed protections. The Federal Deposit Insurance Corporation (FDIC) protects you from losses at banks while the National Credit Union Share Insurance Fund (NCUSIF) offers similar protections at credit unions. Not all banks and credit unions are insured, so it’s best to check.

FDIC and NCUSIF insurance protect funds in checking and savings accounts as well as certificates of deposit (CDs) and money market accounts. However, they don’t cover investments in stocks, bonds, ETFs, mutual funds, insurance products, or Treasuries. FDIC insurance also doesn’t protect against theft, but most banks carry separate insurance that does.

FDIC and NCUSIF insurance both protect up to $250,000 in individual accounts. You can also “stack” these protections by placing your funds in different accounts, like $250,000 in checking, $250,000 in savings, $250,000 in a money market, and $250,000 in a CD for a total of $1 million in protected accounts. But be prepared: If you earn interest on or make a deposit that takes the amounts above $250,000 in any single account, the protections don’t extend to cover the funds that are over the limit.

If you need to insure more than these limits allow, you could open multiple accounts at multiple banks and save up to the limits there. Because keeping funds in separate accounts at different banks can get tricky, many brokerages offer the ability to park funds in short-term CDs and other liquid cash holdings, distributed across several banks.

But what if you didn’t receive just plain cash? What if your cousin Eddy left you acres of land? Or your dear grandmother left you numerous shares of stock? Do you convert the stocks to cash? Do you keep Cousin Eddy’s gift in land? Buy more of the same stock? Ultimately, one of the best ways to protect your funds while keeping them productive is diversification.

If that’s a word you associate with investments and financial planning, you’re on the right track. Simply put, diversification means saving and investing in many different financial assets. This limits your exposure to individual risks by mixing your investments among different asset classes, like cash, stocks, bonds, real estate, businesses, collections, and so on. While no single strategy or collection of strategies can protect against loss in each and every situation, working with your financial planner to determine how to best execute a diversification strategy that’s appropriate for you will help to keep your money productive while you sleep easier at night.

That brings me to my next point …

3. Make a financial plan.

Whether you want to use the funds to support your lifestyle so you no longer have to work, use them to grow your wealth, or something else entirely, having a plan for the funds and for your future is crucial.

That’s because, with more funds at your disposal, your goals for your future may change. And even if they don’t, properly managing those dollars will be crucial to your future and will impact the legacy you leave.

Your Financial Foundation

If you’re thinking of using your windfall to get back on track with your goals, pay down debt, or get ahead on your path to financial independence, your financial planner can help you strategize your next steps. As a foundation for your future, you’ll also want to ensure you have your emergency fund “filled up.” You may even add a few months’ expenses as a buffer in case lifestyle creep sets in. With more money available to you, it may — and probably will — be tempting to spend more.

Your Investment Strategies

If you’re planning to continue working but want to reduce your taxable income, you can use your windfall to supplement your living expenses while maximizing your retirement funds. Whether it’s your traditional IRA or employer-sponsored retirement plan, funding tax-advantaged savings vehicles could offer a reprieve not only when you receive your windfall but for years to come. This strategy can also lend itself to helping you further diversify your investments. Plus, it allows you to grow your wealth to reach other goals.

Your Lifestyle Changes

Maybe you’d like to live on your windfall so you don’t have to work and can instead pursue hobbies, use your time to volunteer for your favorite causes, or simply enjoy more free time. Or perhaps you’d like to spend time caring for an aging loved one or traveling. Given your available funds, living expenses, and goals, your financial planner can help you understand how long your windfall could last if you were to maintain your current path. They can also show you how you can make small adjustments to make it last longer — while living the lifestyle you desire.

Your Philanthropic Intentions

Perhaps you’re considering being philanthropic with your funds. Different types of charitable giving can allow you multiple tax breaks over time through charitable trusts, donor-advised funds, or private foundations. All three allow donors to give to qualified charities and receive tax deductions for doing so.

Whatever your goals, working with a full-time fiduciary financial planner can help you bridge the gap between where you are and where you want to be. And having an ensemble of professionals on your team can be crucial as you work through some of the emotions of receiving a windfall or as your priorities change along the way.

Begin by working with a financial planner to establish your new normal. That is, re-establish your current financial position, windfall included. If you have the chance, it can be helpful to begin this relationship when you find out you’ll be receiving a windfall — before you receive the funds — so you can prepare in advance.

You may have a choice to make on how you’ll receive the money, whether as a lump sum or through payout options. It can be helpful to work with a pro to run the numbers as payout options — and the amount you could ultimately end up with — can differ.

And your options for receiving your funds could affect the taxation of your windfall, so be sure to consider the tax implications and …

4. Make a tax plan.

The type of windfall someone receives is also very meaningful when it comes to tax planning. While you may never owe any taxes on gifts, inheritances, and life insurance payouts, other windfalls may be taxed federally or at state or local levels. If you win the lottery or have gambling winnings, you’re going to have most, if not all, of the tax due withheld at payment. Tax may also be due on amounts received via settlements, depending on the type. If you have a big payday from an initial public offering (IPO), you will have a tax bill. However, you may not have much in terms of withholdings, and you’ll also need to work on estimates that depend on the stock compensation plan (RSU, ISO, ESPP, etc.) type.

Given the different kinds of windfalls and differing taxation, it can be helpful to work with a financial planner who has strong tax-planning experience. Once you’ve figured out the tax implications, add them — and funds to cover them — to your financial plan so they don’t surprise you later. Then …

5. Put your plan into action.

Here’s the best thing you can do with your financial plan: Implement it! As things change, remember that financial planning is an action, so be sure to revisit your plan and update it along the way. As you implement your plan, keep the following three time-based stages in mind.

Short Term: Let It Be

For dollars you plan to use in the next 12-18 months, it’s usually a good idea to keep it liquid. That simply means it’s available and sitting in cash — just in case. It could come in handy if an opportunity presents itself earlier than you were expecting, like a sale on the washer-dryer combo you’ve been eyeing to replace your 20-year-old units. And knowing you’ll need it sooner rather than later, you’ll likely want to protect it from investment risk so you don’t lose all or a portion of it to a drop in the financial markets.

A great place to safely hold that cash and make it work for you, at least a bit: A high-yield savings account. You can use sites like Nerdwallet and Bankrate to find one that’s appropriate for you.

If you have a large purchase coming up in the short term, this can be a great time to plan a little in advance. Rather than financing the purchase, you can continue to save in your checking or savings. Then you can pay for your next big purchase out of cash flow — rather than paying another person or institution to loan you the funds. Or you could use your excess cash as a larger down payment to reduce your monthly repayment amounts — and decrease your total interest paid, too. After all, a penny saved from avoiding interest is a penny earned!

Medium Term: Invest It

If you’re a couple years away from using the money — or you’re just not sure what you’ll use it for or when — investing your cash surplus could be an opportunity to see it grow more quickly.  We can help you build a portfolio that fits your appetite for risk as well as your time horizon. With the correct positioning and guidance along the way, you can make the most of your money and have access to it when you need it.

Long-Term: Take (Tax) Advantage

Are you in it for the long term and wanting to maximize your savings? Get ready to save with intent — and reap the tax advantages! A little savvy saving can go a long way toward financial independence.

It all starts with taking advantage of the savviest saving spots. As you go down the list in order if you don’t have access to one area, simply move to the next. If you have access, invest up to the max before you move to the next in the list. And keep in mind that these are only general guidelines. We can tailor them to your unique needs as you make your stash of cash work harder for you.

1. Get the (free) money. Invest up to your employer’s match in your employer-sponsored retirement plan.
2. Protect your health. If you’re on a high-deductible health plan and eligible to open a health savings account (HSA), you can reap a triple tax advantage.
3. Stash it tax-free. Whether you’re eligible to contribute directly to a Roth IRA or are required to take the backdoor Roth IRA route, you could benefit from a double tax advantage.
4. Still have room to save? Head back to your employer-sponsored retirement plan and invest to the max. Although you won’t receive an employer match on these contributions, these plans offer tax-advantaged growth.

You might have decided on your initial game plan, but don’t forget to let us know about your strategy. We’ll be your guide as you continue to manage adding to and/or using this cash surplus. And we can keep our eyes out for other opportunities or to make you aware of potential blind spots in your plan. For some, receiving guidance and validation on how to manage money can be the key to creating more.

Of course, there’s more to your financial life and financial plan than where-to-put-dollars logistics. If you just came into quite a bit of money, you’ll want to review estate planning documents and update them as necessary. You may choose to include donations to your favorite charities or dividing your assets differently among your beneficiaries now that there’s considerably more involved. And checking your account beneficiaries is always a good idea when account values change drastically. An attorney who specializes in estate issues can help you craft the right estate plan for you.

Your cash-flow plan — aka your budget — is also important early on after you’ve received a windfall. Going back to the logistics, there is a lot of low-hanging fruit when it comes to coordinating investment, tax, and spending plans. Pragmatic steps like maxing out tax-qualified investment vehicles and living on a cash supplement from your windfall are just the tip of the iceberg.

All said, making the best use of a windfall doesn’t have to be difficult. It can simply involve shifting your money mindset. Instead of letting the cash sit in your checking or low-interest savings account, would it be better to instead direct more pre-tax dollars to your 401(k) or similar employer-sponsored plan for the long term? Might it be better to simply change the location of the funds from your checking account to your high-yield savings, HSA, or Roth IRA? Or is that shift your chance to allow yourself to spend some of the surplus?

Sometimes, you’ve just got to treat yourself!