You come into some extra cash and are wondering how to best use it. Whether it is a tax refund or an inheritance, the welcome sum can help you move closer to your life goals.
In building wealth, it is wise to avoid using other people’s money – such as loans from credit cards- to defray monthly living expenses. If you have credit card debt you may be paying back the balance at an interest rate exceeding 20 percent. When advising clients I tell them to apply any windfall money to the goal of eliminating debt that is billed at such as exorbitant rate of interest.
If you are lucky enough not to owe on credit cards, then it is important to review short term and long term goals for financial health. Check in with your significant other about how to prioritize these vs. other practicalities of daily life.
For instance, if you have no emergency fund reserve, build that up as a first priority, to avoid resorting to credit cards to cover an emergency. If you have been underfunding retirement savings, consider allocating at least part of your windfall to a retirement account for yourself and if married, to your spouse, to earn deductions on this year’s tax filing.
There are high yield money market savings accounts available for the risk averse, tax exempt bonds and funds for the tax shy, and stock funds and stocks for people who are optimistic about market returns. If your time horizon is long, you can accept more risk to build the value of your investment significantly over time.
People often ask about paying off a mortgage, when receiving larger sums of money. Yes, it is a great feeling to achieve liberty from the mortgage lender. But keep in mind you will lose a yearly deduction on your taxes for the interest portion of your mortgage payment. If you are receiving Social Security benefits, you may find that you owe income tax on a larger portion of your benefits if you no longer have this interest deduction to lower taxable income.
If the windfall is very significant, or even a life changing event such as a lotto winning or sale of intellectual property or a business, then further planning is warranted as well as a check in with your core self about what is really important to you in life. If you care deeply about family, think about how to use the money to strengthen family ties and promote more well being over time. If the money is invested it can grow to an even more significant sum to fund education, purchases of real estate, more than the occasional donation to church or a charity, and provide working capital to launch or purchase a business, for instance.
With a larger sum of money comes complexity and I advise anyone receiving an unexpected windfall to seek out a lawyer to create or update a will or trust. I also advise people to find a very good tax accountant, as taxes are a fact of life. Investing for the future will bring higher taxes potentially on income realized from the investments.
Whatever you decide, don’t just spend the money and assume that tomorrow will bring another day of good fortune. Sometimes windfalls are just that, not to be expected very often. It is always wise to have reserves for the unexpected events and opportunities of life.
Financial foresight creates many positive returns. Talk to us about your goals and we can develop a plan.
