How to handle a windfall

Photo illustration about the choices that lean to financial freedom as shown by a woman walking in the woods

When my father died in 1995, he left behind a small life insurance policy that awarded each family member $5,000. It wasn't much, but it was the best he could do based on the fact that he had cancer. He hadn't been much of a planner, and hadn't been good with money, so that $5,000 per person was actually a significant amount.

At the time, I was deep in debt. I had over $20,000 in credit card balances, and was gradually adding more all of the time. If I'd been smart, I would have taken the proceeds from my father's life insurance and used them to immediately repay $5,000 in debt. But I wasn't smart.

I used $1,000 to pay off debt (and patted myself on the back for it), but spent the rest on a new computer, software, and accessories. It didn't take long to realize that this was a dumb decision.

You see, when you receive a windfall, whether it's a tax refund, an inheritance, a gift, or from any other source, it's like you've been given a second chance. Although you may have made money mistakes in the past, you now have a chance to fix those mistakes (or some of them, anyhow) and start down the path of smart money management.

Related >>How to Spend a Tax Refund

It can be tempting (as I well know) to spend your windfall on toys, trips, and other things that you “deserve,” but doing so will leave you in the same place you were before you received the windfall. And if that place was chained to debt, you'll be just as unhappy as you've always been.

Since my father died, I've received a few other small windfalls (and a very large windfall when I sold Get Rich Slowly). With time, I've developed a system for handling these situations.

If you receive a chunk of cash, I recommend that you:

  1. Keep 5 percent to treat yourself and your family. Let's be realistic. If you receive $1,000 or $10,000 or $100,000 unexpectedly, you're going to want to spend some of it. No problem. But don't spend all of it. I used to recommend spending 1 percent of a windfall on yourself, but from talking to people, that's not enough. Now I suggest spending 5 percent on fun. That means $50 of a $1,000 windfall, $500 of a $10,000 windfall, or $5,000 of a $100,000 windfall. Don't be tempted to spend more!
  2. Pay any taxes due. Depending on the source of your money, you might owe taxes on it at the end of the year. If you forget this fact and spend the money, you can end up in a bind when the taxes come due. Consult a tax professional. If needed, set aside enough to pay your taxes before you do anything else.
  3. Pay off debt. Doing so will generally provide the greatest possible return on your investment (a 20 percent return if your credit cards charge you 20 percent). It'll also free up cash flow; if you pay off a card with a $50 minimum monthly payment, that's $50 extra you'll have available each month. Most of all, repaying debt will relieve the psychological weight you've been carrying for so long. Don't underestimate the feeling of freedom that comes from no longer having creditors.
  4. Fix the things that are broken. After you've eliminated any existing debt, use your windfall to repair whatever is broken in your life. Start with your own health. If you've been putting off a trip to the dentist or a medical procedure, take care of it. Do the same for your family. Next, fix your car or the roof or the sidewalk. Use this opportunity to patch up the things you've been putting off.
  5. Deposit the rest of the money in a safe account. It can be tempting to spend the rest of your windfall on a new motorcycle or new furniture or new house. Don't do it. Take some time to breathe. After attending to your immediate needs, deposit the remaining money in a new savings account separate from the rest of your bank accounts. Be sure that the account is as difficult to access as possible — no ATM card, no easy transfer to your other accounts, no nothing. (An online savings account is good for this. So is an account at a small, local bank in the next town over.)
  6. Make a wish list. Allow your initial emotion to pass, getting over the urge to spend the money now. Live as you were before. Meanwhile, spend some time learning how far your windfall could go. Most people have unrealistic expectations about how much $10,000 or $100,000 can buy. Resist the temptation to spend the money now, but do run the numbers to see what you could buy.

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In the end, it's often best to take the remainder of a large windfall and invest it for growth.

You've already repaid your debt and fixed the things that are broken, both of which are methods to spend on your past. You've also used 5 percent to treat yourself and your family, which is money spent on your present. The smartest move with the rest of the money is to spend on your future by funneling the funds into an investment account. (If you don't know how to do this, consult an investment professional.)

When I sold Get Rich Slowly in 2009, I received a large windfall. The old J.D. would have gone crazy with the money. The new, improved model of me was prepared, however, and made measured moves designed to favor long-term happiness over short-term happiness. Yes, I spent some money on new furniture and a trip to Europe. But I also set aside money to pay my taxes (fortunately, I was debt-free by that point) and to fix the problems in my life. (I was 50 pounds overweight in 2009, so I allocated $200 per month to becoming fit.)

Today, the bulk of my windfall still sits in the same place it's been for the past five years: an investment account. When first I put the money there, I thought I might use it for something in the not-so-distant future. That didn't happen, and now I've had time to get used to the idea that I have a large chunk of money that can act as a sort of “personal insurance.” That cash eases my mind. It helps me sleep easy at night. And that's more rewarding than spending it on new toys could ever be.

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Frugal Finn
Frugal Finn
6 years ago

Very good points, I just received 2000€ in early inheritance from my grand parents and the whole sum went straight in to our savings account. Not going to touch that money at all.
Usually when I receive larger sums of money I invest&save 75% of it and spend 25% of it (If there is something that we really have been wanting to buy for a while)

Simple Money Concept
Simple Money Concept
6 years ago
Reply to  Frugal Finn

Yup. You are right.

Quick story. I was working with a person who inherited a large sum of money when her neighbor passed away. She initially wanted to save that money, but there were too many temptations along the way, she ended taking out the money slowly and gradually to a point where most of the money was gone after about two year.

Try to avoid the temptation and don’t mention it to other people.

Beth
Beth
6 years ago

I like the point about using at least a little of it for yourself and your family. I received a gift from a family member once and saved/invested the entire thing. Now that he’s gone, I regret spending at least a little of it on something fun. Something that I could have shown him or told him about.

I really hope my heirs will do the same someday. Save, yes, but do something memorable.

Frugal Finn
Frugal Finn
6 years ago
Reply to  Beth

Sure, I do agree with you. In my case this was just a early inheritance in order to avoid taxes. Hence this was all saved since there was no “emotional” attachment to it.

Beth
Beth
6 years ago
Reply to  Frugal Finn

I definitely agree emotion makes a difference — at least in my case! I feel guilty/awkward/embarrassed/humbled/grateful about having money I didn’t earn.

I’m glad to see positive comments on this post rather than “must be nice” sort.

Matt
Matt
6 years ago

Good ideas here on handling a windfall – I usually go with 10% for me and 90% for saving/investing/debt/etc.
Do your percentages change based on the size of the windfall?

cathleen
cathleen
6 years ago

I’ve had a number of windfalls in my life and each one has had an emotional component that came with the check. My father died young and his life insurance was 6 figures. My mother was in such grief that I took over her finances amid her financial anxiety and panic that the money wouldn’t last her to old age. I then received my dad’s portion of his inheritance from my grandmother. My cousins (who had a deceased parent as well but who had received a “payout” early from my grandmother) took us to court. How charming. This dragged out… Read more »

Jean
Jean
6 years ago

I also think it is a good idea to donate a portion to a Charity of your choosing. Pay it forward. 🙂

Jonathan
Jonathan
6 years ago

It would depend how that windfall came about. For example, we refinanced some rentals and got a 6-figure “windfall” – we didn’t spend a dime of it, and it’s all going to new investments as we come across them. But that wasn’t “new money” because it came out of equity in our properties. I think it would take quite a large unexpected windfall (at least 6 figures) for us to consider spending any of it on anything but additional investments or charitable giving. Between our income and savings and our general frugality, extra cash has no immediate utility (or emotional… Read more »

lmoot
lmoot
6 years ago
Reply to  Jonathan

Perfectly said. At this point in my life I’m more likely to view a windfall as “now I have extra tools to make the best net, to catch my own fish” rather than “hey, thanks for the mahi mahi!”.

Paul in cAshburn
Paul in cAshburn
6 years ago
Reply to  lmoot

I hope everyone listens to your sage advice LMOOT. Use windfalls to improve your ability to catch more fish. Or, use windfalls to set up passive income streams that will endure.
Paying off debt, paying for things you need… ok, but if you’ve been frugal and don’t have needs like that – make the windfall a permanent part of your future income stream, one way or another. That’s how you get rich, slowly.

DreamChaser57
DreamChaser57
6 years ago

Your voice and perspective resonates with me, good to have you back, JD.

One practice that hubby and I have done with anticipated windfalls, is to write out a budget BEFORE we get it. To borrow Dave Ramsey’s phrasing, once you give every dollar a name, I can immediately implement the budget. We debate about our financial priorities and the direction we want to go before we have the money in hand.

It helps to optimize windfalls and avoid careless and frivolous spending

Bob
Bob
6 years ago

I very recently received a windfall (life insurance and inheritance) and am still deciding what to do. When all is said and done, the total will be about $120,000. So far, I have used $30,000 as a down payment on my first house and rolled over $65,000 into an inherited IRA (it was in a traditional IRA) and am planning on keeping it there for my own retirement (minus the required yearly withdrawals). The last $25,000 I should receive within the next year (government retirement account, so ridiculously long processing time). For that money, I’m really not sure what to… Read more »

lmoot
lmoot
6 years ago

I’ve received a couple windfalls over the years, all of which went towards school and that wasn’t really a decision on my part, though I would have made the same decision. I’m not really the sort to make plans based on a windfall. Usually I already have ideas of how to spend money (the only difference is the source…getting money versus earning money). Therefore I am not likely to go on some big vacation because of a windfall, unless it was a vacation I was planning to take anyway, which I would have already been saving for so whether I… Read more »

PawPrint
PawPrint
6 years ago
Reply to  lmoot

I’m not a big fan of getting tax returns either, but for some people, particularly those not good with money, it’s forced savings. I’d rather have all the money I’m entitled to each month so that I can save in some kind of interest-bearing or dividend-paying account. However, I’ve had fairly large tax refunds since buying rental properties. When it was just income from regular sources, it was easy to adjust withholding. Now I have no idea how to adjust the withholding from the job because I don’t know what income (somewhat predictable) or expenses (unpredictable) to expect with the… Read more »

Jacq
Jacq
6 years ago
Reply to  lmoot

I’m not thrilled about getting a tax return, but I do get a fairly significant refund almost every year because I do contract work and only work part of the year. And when I do work, much of my income is at the highest marginal rate. I’ve also saved up RRSP contribution room from lower earning years to offset against high earning years so it’s not uncommon for me to get low 5 figure refunds. I just do the boring thing and save all of it. But yeah, the people I know that are the worst with money are the… Read more »

Slinky
Slinky
6 years ago
Reply to  lmoot

This is usually how I treat windfalls too. Whether I earn a little extra, get an unexpected windfall, or find extra money in the budget, it all gets treated the same. Sometimes it goes towards the thing I’m working on now, or I might leave my budget as is and hit the next thing on the list. That depends entirely on the goals and when I need the money by. I’m also normally right with you on the tax returns, but this year is an odd one. I’m actually getting a bunch back. This is only because we bought our… Read more »

Samithepolopony
Samithepolopony
6 years ago
Reply to  lmoot

I have NEVER understood giving the government an interest free loan all year just to collect some back as a “refund”. That is the behavior of a child who cannot be trusted to handle their own money year around. I foolishy spent a $6000 windfall in my twenties and learned my lesson. I agree we should all be saving towards what we want/need to do without the assistance of a windfall. I am debt free for the third time in my life and I like the idea of spending 10% since I have no debt to pay off. I also… Read more »

Another Beth
Another Beth
6 years ago

As always, J.D., I enjoy your perspective and I loved the topic of this post.

I just wanted to add that if one is in a relationship, then make sure you are both on board with what to do in case of a windfall. It doesn’t help if one person follows JD’s advice while their partner is spending like there’s no tomorrow.

mary w
mary w
6 years ago

If the windfall comes from a person (inheritance or gift) I think it’s nice to consider what a giver thought was important. If your grandmother thought owing your own home is important then using an inheritance from her as a house down payment would be great. Or if your bachelor uncle gives you money because he saved all his life then using the gift toward an IRA is a nice thank you.

This all can be taken too far, of course. Don’t buy a Chanel purse rather than pay-off student loans just because the money came from your fashionista aunt.

Geoffrey Sadler
Geoffrey Sadler
1 year ago
Reply to  mary w

Mary, I agree with you, this business of windfalls can be taken too far. Hey, some people never learn. I have numerous baby boomer friends like that… that feel they will retire comfortably on an inheritance windfall and so don’t bother with their own affairs so much. In fact one in particular who had gotten a nice windfall, inheritance in Virginia a few years back. Hey, there are always going to be people who waste a lot or all of their inheritance money… We all know you don’t have to be 18 to be foolish with money, but I’m sure… Read more »

Honey Smith
Honey Smith
6 years ago

I think I would probably be more 10% fun, 90% savings/debt…until the windfall got ridiculous (which to me would be more than $10,000). The most extravagant thing I could think of that I don’t *need* would be a yoga gym membership, which for a year unlimited would be about $1000. I suppose if I got like $100,000, then I would set aside $10,000 of it to buy a new car (my current car is 14 years old). But I would not actually buy the new car until my current one died. So I’m not sure where that falls in the… Read more »

Korah Morrison
Korah Morrison
6 years ago

Thank you for your informative explanations on handling a profit with those really good recommendations. I’m glad I found it helpful. 🙂

Amy
Amy
6 years ago

Great post, J.D.! Sure do miss you on this blog.

scotteeth
scotteeth
6 years ago

first time posting a response as i have been moved…..to a degree. i am surprised that only jean mentioned anything about giving unto others (not necessarily with any religious overtones, as i am not!) my dad’s favorite book was magnificent obsession and we used his death and windfall to educate his heirs and grandchildren as to the wonderful aspect of blind charity (giving without any stings attached or even knowing the donee.) its a feel good thing………..try it!!

That Career Girl
That Career Girl
6 years ago

Great points, this should be printed out and given to everybody who wins the lottery.

wes@GenWiseWealth
6 years ago

Thanks for this article. It’s far too often that people simply run out and buy that new car, big screen TV, or vacation when receiving a large sum of money. We ought to instead take a couple days or weeks to really think about the best use of that money over time. After paying off high-interest credit cards and other short term necessities like taxes due, the best course of action is to invest in a long-term oriented mutual fund or ETF. Invest and forget.

D Smith
D Smith
6 years ago

I recently had $7,000 returned to me that was the proceeds of stock that was held by the state of Delaware because it was unclaimed by me (forgot to update my address changes).

First thing I did was try to put half of it towards paying down some debt.

Second thing I did was invest the rest in a local ETF (which I intend to hold for 21 years as a part of my Get Rich Slow strategy).

I didn’t keep any for myself though. 🙁

Mr Smith
Mr Smith
6 years ago

Best way to make sure you don’t blow your windfall is to ask yourself,
“How much would this money be worth in 20 years if I invest it!”

Milissa
Milissa
6 years ago

The only change I might make to J.D.’s recommendations is to fix the broke things before paying off debt. Especially tending to preventive medical issues before they become much larger medical expenditures. Or dealing with a small leak before it becomes a major issue in your house. Or if you want, use the 5% fun money toward fixing those things first.

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