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Smart Money

What Is a Windfall and How Do You Manage One?

While it may be tempting to spend windfall money right away, planning before acting impulsively will help you maximize your windfall benefits for the future. Learn how to manage and invest an unexpected large sum of money.

Katana Dumont • December 21, 2021

We’ve all fantasized about winning the lottery or finding a suitcase full of money, but have you ever thought about what you would actually do with a surplus of unexpected cash? While quitting your day job and buying a mansion might be at the top of your list when you get a large amount of money all at once, your first priority should be making a financial plan to properly manage it, so its value isn’t fleeting.

Receiving an influx of cash is actually more common than you might think, and planning for it now will better prepare you to make the most of a sudden financial windfall.

In This Article

  1. Windfall Definition
  2. What To Do With a Windfall
  3. How to Manage a Windfall
  4. FAQs
  5. Final Thoughts

Windfall Definition

A financial windfall refers to an individual or a company gaining a large sum of money, typically unexpectedly. 

Examples of a Financial Windfall

There are many ways a person might come upon an unexpected amount of cash. Some of the most common examples of a financial windfall are as follows:

  • Inheritance
  • A lottery prize
  • Casino winnings
  • A work bonus
  • Tax refund
  • Sale of a property
  • Severance pay
  • Winning a lawsuit

What To Do With a Windfall

No matter how you might have come upon a windfall of money, it’s important that you know how to properly invest it. This extra cash is a great opportunity to improve your financial situation, but without a plan you can easily squander your good fortune. 

There are several steps you can take to make the most of your newfound income. 

1. Pay Off Debts 

While paying off debts is not nearly as fun as it would be to buy that new purchase you’ve been eyeing or booking a trip to your dream destination, it’s a wise financial move to make for your future.

A sudden cash windfall can seriously help alleviate financial stress and help you get caught up on your debt obligations, such as student loans, mortgages, or credit card debt. Eliminating all or even some of your debts will free up your monthly cash flow and allow you to save money on interest rates by paying off debt early. 

2. Create or Add to an Emergency Fund

Life is unpredictable and, just as unexpected as a financial windfall, unforeseen events can severely catch you off guard and hurt you financially if you aren’t prepared. That’s why having an emergency fund is vital and building it up is one of the first things you should do with your windfall assets.

Emergency funds are typically cash accounts separate from your primary checking and savings accounts with enough funds to cover 3-6 months worth of living expenses in case of income loss or other unforeseen problems. In preparation for life’s curveballs, dedicating a portion of your windfall to an emergency fund will give you more financial peace of mind. 

3. Contribute to Your Retirement 

No matter how old you are when you receive a cash windfall, you can use that extra money to contribute to your retirement nest egg. If you have an employer-sponsored retirement fund, such as a 401(k), or a retirement savings account, such as an IRA, you can use your windfall to fund these accounts to the maximum annual amount allowed by the Internal Revenue Service (IRS).

By doing this, you’re allowing your investment to grow and potentially provide you a greater return when it’s time for your retirement. Maxing out your retirement fund contributions each year allows you to better take advantage of compound interest, which can grow a single windfall into longer-term gains.

4. Build Wealth Through Investments

Investing is a great way to augment your windfall benefits and make them last. There are endless investment opportunities that you could look into. Among them are stocks, bonds, rental properties, business startups, and mutual funds, just to name a few.

Ultimately, the types of investments that are right for you will depend on several factors, including how much money you have to invest, how much risk you’re willing to take on, and how long you’re willing to wait for your funds to grow. Keep in mind that diversifying your investments might be the best way to minimize risk.

5. Start a Business

If you’ve got a business idea and a dream to be your own boss, why not use a portion of your financial windfall to help fund it? If you create a successful business, you are maximizing your windfall assets by using it to grow your business earnings.

A financial windfall can also offer you the breathing room to help reevaluate your career goals. Maybe you are not fulfilled in your current position and are looking for a change. With the extra funds, you can create a plan to leave behind a job you don’t enjoy, while charting a path toward a new career.

6. Spend Sensibly 

After doing all, or most, of the above, it’s now time to treat yourself. While you’ll initially want to hold off on splurging away your windfall cash, it’s OK to put some of the money aside to use for sensible spending. Maybe your home could use some upgrades or you’ve got your eye on a new car. Prioritize what matters most and use some of your newfound cash to improve your quality of life. 

How much you set aside depends on you and your financial obligations, but don’t forget to set some boundaries. Consider a budgeting technique like the 50/30/20 rule, in which you divide your after-tax income into 3 spending categories: 50% for needs, 30% for wants, and 20% for savings or paying off debt. 

How to Manage a Windfall

Follow these best practices, when it comes to properly managing your windfall finances.

  • Enlist the help of experienced professionals — consider accountants, tax advisors, financial planners, and estate lawyers to help you manage your windfall. 
  • Make a list of your top financial priorities and goals — assessing your financial goals will keep you focused on what matters most and will help you maximize your windfall benefits.
  • Donate some of the money to a charity —  this can lighten your tax burden while helping a cause you care about.
  • Open a high-yield savings account — placing some of your windfall money into a high-yield savings account will help it continue to grow. 
  • Evaluate your tax obligations – determine whether or not the money you’ve gained from a windfall is taxable, and if it is, you should set aside enough money to cover the taxes.

What Is a Windfall Tax?

Depending on the source of the windfall, and how much you received, you may owe the IRS what’s known as a windfall tax on the profits. Make sure to determine your tax obligations, and set enough money aside to pay any windfall tax.

FAQs

What are windfall profits?

Windfall profits are a type of windfall gain that refers specifically to circumstances in which a profit is made. For instance, selling real estate property could be an example of a windfall profit. But receiving an unexpected inheritance is only a windfall gain, since the inheritance was given to you and not sold for a profit.

Windfall profits also have their own taxation regulation known as a windfall profits tax. This tax is usually applied to companies who have made an unforeseen profit due to unexpected demand or government regulations.

How much money is considered a windfall?

There is no defined amount of money that qualifies as a windfall: It’s any amount of money that you didn’t expect to receive and is over your regular income. For most people, a windfall can be any amount over $1,000. A good rule of thumb is that a windfall is any amount of money that makes a significant financial difference in someone’s life.

Final Thoughts

Bottom line, if you do receive a cash windfall, resist the urge to spend it all at once. Instead take the time to develop a strategy for how best to take advantage of the influx. There are a lot of ways you can make a cash windfall last and even turn it into significantly more money. Review your financial goals, and make a plan that will help you achieve them now and in the future.

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