What To Do With a Windfall
Play video  

If you receive a windfall, such as an inheritance, gift, large tax refund, or even if you win the lottery, take a deep breath and consider these choices:

• Don't Rush. You may discover friends and relatives you never knew you had. You may also hear from lawyers, financial planners, charities, and people offering all sorts of "opportunities". Perhaps this is why a large percentage of lottery winners are broke within 5 years! There is no law that you have to invest or spend this money right away. The best thing to do with any immediate cash you receive is to put it in a money market account.
  

• Talk to a professional tax accountant. Either speak to a tax advisor who comes recommended by someone you trust or do your own research to determine:

1. Do you need to pay tax on the money you will receive? Life insurance is tax-free, but an inherited IRA account is taxable (unless it's a Roth IRA).

2. Will you have to make estimated tax payments

3. Even if tax was withheld from your money, it may not be enough.

4. Can you defer paying tax until the future? Some inherited pension accounts may be rolled over and withdrawn over a period of time. While you will eventually pay tax on the money, it will probably be at a lower rate.

5. Set aside any money needed for taxes so that it's there when it comes time to pay. Otherwise there will be penalties and interest.
   

• Review your Net Worth statement (or prepare one), and see how your windfall will fit in.On the Liability side, if you have high-interest debt, pay that off first. Paying off credit card debt is like earning 16% or more on your money!

On the Assets side, you can use the windfall to improve your asset allocation. For example, if most of your assets are in real estate (your home), you can invest in equities through mutual funds. This will allow you to benefit from diversification.

• Talk before you spend. If you can afford to spend a portion of your windfall, decide how much will go to which purposes. It's best to involve your family in this decision. Once you decide on an amount to be spent, set that money aside in a separate account so that you won't go over your spending budget.
  

• Begin investing your windfall. Don't invest all of it all at once. Instead, invest your funds over a 6 to 18 month time frame (depending on the amount and its percentage of your net worth) is a good idea. Think about it: you don't want to invest a lump sum and soon find out that you put it in the stock market at a "peak" just before a long-term decline. By spreading your investment over several months, you can take advantage of the benefits of dollar cost averaging. Many mutual fund companies will help you out with "periodic investment plans."