How to Financially Prepare for Windfalls
Windfalls can come in many forms: selling a business or real estate, receiving an inheritance, settling an insurance suit, obtaining a large bonus, or receiving a pension in a lump sum. Here are some financial implications to receiving a windfall: Reassess: The first step is to reassess your current financial plan and where you stand. How does this windfall affect your financial life? Is it significant enough for you to make meaningful changes in your life now or in the near future? Replenish: The next step is to replenish your emergency savings. Typical emergency savings funds have somewhere between 3-6 months worth of all necessary expenses.
Tax Planning: After you've topped off savings, consider tax planning opportunities. To start, you must set aside an appropriate amount of money to pay taxes on any windfall received. Additionally, you may be able to max out retirement or HSA plans to reduce taxable income. Donating to charity may also be a good way to offset an increase in taxes from a windfall.
Spending: Usually, we like to consider spending before any other aspects of our financial plan. It is important to pause and take care of all your other financial needs prior to spending any amount from your windfall. Debt: If you have high interest debt, using your windfall to pay it down (or off!) can significantly reduce your interest expenses. Savings: Put the rest of your windfall into long term savings and/or a diversified portfolio of investments.