How to Make your Extra Money Work for You

Sometimes in life, you get lucky. The person in front of you buys your coffee, you are gifted tickets for your favorite team, or you make every green light on the way to work. Of course, sometimes this luck involves money, and it has the potential to change your life.

Sudden windfalls can take many forms. You could bring home extra cash from gambling winnings, an inheritance, or even a financial gift. It could also be the best result from a bad situation, such as a lawsuit settlement or severance package. No matter where the money comes from, though, it’s important to plan how to put it to work for you.

By having a plan in place, you can not only optimize your financial impact, but you will also avoid the all-too-common tendency to fritter it away.

Take the Time to Make a Plan

I’ll admit it: I dream about winning the lottery sometimes. Since I’m not in the wills of any rich uncles (that I know of) and I doubt anyone I know will be gifting me with some serious cash anytime soon, the lottery is probably my best chance for a sudden windfall. And boy, oh boy do I have my new-money strategy all figured out.

First, I would pay off my mortgage, student loans (sayonara, Navient!), and auto loan. The rest would be a combination of paying off my parent’s house, fully funding my kids’ college savings, fully funding my retirement accounts, traveling the world, and giving some to charity. I’ve given this some serious thought over the years, and my strategy has changed along with my life and obligations. (Now, I just need those winning numbers to hit! I’m ready for it.)

Depending on where your finances currently sit, though, your priorities might be a little different. In fact, there are a few things that you should absolutely focus on first, whether your unexpected windfall is $250 or tens of thousands of dollars large.

You might have a plan in place long before the dream money arrives (if it ever does) or you might be caught off-guard by a sudden influx. No matter what, though, the important thing is to establish a plan before you do anything. Even if that means parking the money in a savings account or short-term CD until you can figure out exactly how to optimize the spending.

Related: For the best CD rates, visit CIT Bank or Discover Bank 

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Think About Taxes

The very first thing you should consider when coming into extra money is the tax implication of those funds. Depending on where they come from and what you do with them, you could wind up with a seriously inflated tax bill come next April.

Cash gifts are generally safe, up to a certain amount. This means that if your parents or Aunt Sally want to write you a $15,000 check for Christmas, you’re in the clear. Since this doesn’t cross the annual gift tax exclusion threshold ($15,000 in 2018), neither the giver nor the receiver has to worry about Uncle Sam taking his cut. Beyond that amount, the donor is supposed to report the gift and pay necessary taxes, but in certain cases (if the taxes go unpaid), the IRS can come after the donee instead.

Gambling winnings–whether through a raffle, on a lottery ticket, or in a casino, among others–must be reported as income. This means that come April, you will need to pay taxes on those winnings according to your overall tax bracket. This also means that you should take measures to lower your taxable income throughout the year and reduce the amount due.

If you inherit your windfall, it may or may not be subject to taxes, depending on the nature of the funds, the amount inherited, and even the state in which you live. For instance, some states charge an inheritance tax, though it will usually be taken out of the funds before you ever even see a check. There are also estate taxes to worry about if you are inheriting a sum of money from a large estate. If you inherit a 401(k) or IRA, or even property, you will need to pay taxes on the deductions or capital gains resulting from either.

If you aren’t sure about the tax implications of the money you’ve come into, you should consult with a tax advisor to be sure. By planning ahead for your tax bill, you can not only optimize your investments and spending to reduce your taxable income, but you can also avoid spending your windfall only to get stuck with a tax bill you can’t afford the following spring.

Focus on High-Interest Debt

Whether you come into $500 or $50,000, your first focus should be on high-interest debt. Credit card interest rates are an average of 15% but can easily top 30% on some products. If you have private student loans, you probably have some high interest rates (some might even be variable). This means that you are throwing a substantial amount of money into a hole each and every month because of your balances.

If you are carrying around high-interest debt, your windfall should first be directed at clearing out those accounts. Even if you don’t have enough extra money to pay down the balances entirely, you can still make a dent with your extra funds. This will not only mean less interest charged each month, but will jump-start your payoff progress.

You shouldn’t worry about low-interest debt just yet, such as an auto loan (usually 3-5% or so) or even your mortgage (averaging 4.7% right now).

Build an Emergency Fund

Did you know that less than half of Americans have enough money on-hand for a sudden, $1,000 expense? This means that if they have an unexpected medical or dental issue, if the water heater suddenly leaks, or if they lose their job, they don’t have a safety net. Credit cards can be a fall-back, albeit a dangerous one, but if those are already maxed out or unavailable, you could be one emergency away from homelessness.

Having an emergency fund in place gives you peace of mind in case something comes up, and can be the safety net that you need to make it out of an emergency situation.

If you’ve already taken care of high-interest debt, your windfall should next be directed at funding such an account. Start by building an emergency fund that can cover a full month’s worth of expenses in your home. Then, build up to one and two months. Your goal? A full six months’ worth of expenses, from your mortgage payment and insurance to gas, groceries, and utilities.

Think About Clearing Other Debt

Next on the list for you might be clearing out other, smaller/lower-interest debt, depending on your personal priorities. For some of us, this could mean paying off a mortgage (our own, mom and dad’s, or even grandma’s) or auto loans. Even though the interest rates on these are probably reasonably low, the peace of mind that comes from eliminating the debt could be exactly what you need to de-stress.

Some argue against this, opting instead to invest those funds (where you could be earning 7-8% or more a year in interest) versus paying down a debt that only charges 4% or so. However, investments aren’t guaranteed; by getting yourself entirely debt-free, you can have the financial freedom and peace of mind that you may desire.

Invest Wisely

Depending on your priorities and current financial situation, investing might be next on your list. For some, it may actually come before paying off smaller, lower-interest debt. It’s really a matter of personal preference at this point.

Building an investment portfolio with your windfall can vary depending on your interests, the amount of money you have to invest, and even where you are on your road to retirement.

If you are still working and haven’t already maxed out all of your tax-advantaged retirement accounts, this should be your priority. These accounts allow you an easy way to reduce your tax burden, and you should jump on that every chance you get.

If you’re already maxed out for the year on your 401(k) or IRA accounts, you could earn some interest by investing your money. You could choose to allocate some of the funds to peer-to-peer investing, for instance. These types of loans have a certain level of risk involved but the returns are excellent. You could also work with a robo-advisor (like Personal Capital) or financial advisor to choose funds and even individual stocks that interest you, and build up your investment portfolio.

Buying another home or investment property might be the right answer for you. Even if you just use your money as the down payment on a new house, it can still be an excellent investment. Just be careful: being able to afford the down payment doesn’t necessarily mean you will be able to afford the home in the long run. Be sure to plan your purchase(s) wisely.

Make Charitable Donations

I personally believe in tithing and doing for others, so my win-the-lottery dream has always included charitable causes. While my plan would be to donate 10% of my windfall to others, this may vary wildly for others. The percentage isn’t the most important thing here, but doing good for others when you can should always be on the list.

For you, this could take the form of donating to your church or an organization that speaks to your heart. You could also start a scholarship fund for underprivileged youth, support a special program in your area, or any number of other avenues.

Be sure to consult with a tax advisor regarding the implications of your donation. There may be ways to optimize your charitable giving so that you also reduce your taxable income in the process.

Plan for the Future

I have two small children, so their future is always on my mind. One of them has special needs as well, so that opens up a whole new can of “planning for the future” worms.

Whether planning for their inevitable education expenses to setting aside extra money for down payments, their wedding, etc., it would be great to establish funds for their future needs. I don’t necessarily want to create “trust fund children,” even if I could afford to do so, but planning for specific needs down the line is a priority of mine.

If setting aside educational funds, look into utilizing a 529 account. This tax-advantaged plan will reduce your income tax burden and also earn them interest as it grows. If they are working, you can also use the money to fund a Roth IRA for them; just be sure that you don’t cross the maximum contribution amount or the amount of money they actually make this year, whichever is lower.
Of course, be sure to also address your own future, as we talked about in the retirement account/portfolio section above.

Have (a Little) Fun

While it’s important to be smart and intentional with your windfall spending, it’s just as important to have a little bit of fun. After all, work and no play can drive anyone crazy.

Set aside a specific amount to just enjoy life with–this would be another 10% for me personally. I would use that money to travel the world or just buy myself a pair of fun shoes (depending on how much money I came into), but you can set whatever amount you’d like. Just be sure that you’ve left yourself enough to take care of the really big priorities, like high-interest debt.

Update Your Estate Plan

Once you’ve decided how to spend your windfall and allocated funds to the appropriate accounts, it’s important to then update your estate plan. Failing to do so could mean serious tax implications later on (for your heirs), many of which could be avoided with the right planning.

Consult with a financial and/or tax advisor if needed, to see how you can create a new estate plan that accounts for your newfound funds. If you only come into a few thousand dollars, this obviously isn’t an issue for you–when I inevitably win the Powerball, though, you best believe that I will be calling up an advisor first thing to create a decades-long plan for my money.

Coming into funds is exciting and almost always a welcome surprise. However, there are smart ways to spend this money and there are dumb ways. By planning your spending intentionally (and even consulting with an expert or two), you can maximize your new funds and ensure that they go the furthest.