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Understanding and Managing Financial Windfalls

From discovering a $20 bill in your winter coat to receiving a surprise bonus at work, financial windfalls can make life a little sweeter. A financial windfall is unexpected money that can range from hundreds to millions of dollars. Regardless of the amount, it offers an opportunity to improve your financial situation. Here’s a closer look at where financial windfalls come from and what to keep in mind if you receive an unexpected influx of cash.

What Is a Financial Windfall?

The Cambridge English Dictionary defines a windfall as “an amount of money that you receive unexpectedly.” The surprise can be in the amount, the money itself, or both. For instance, you might know your parents are leaving you an inheritance but be astonished that it’s $10 million. Alternatively, you might receive an inheritance of $1,000 from a distant cousin you never knew existed.

Examples of Financial Windfalls

Financial windfalls can come from various sources, including:

• Profit from the sale of a home or other property
• An employee bonus
• Prize or lottery winnings
• A life insurance payout
• Inheritance of money or property
• Exercising stock options
• The payout from a lawsuit
• A tax refund

What differentiates a financial windfall is that it’s unplanned and not part of your regular income and budget. This can be a win for your finances but can also present new money management challenges depending on the size of the windfall.

How Much Money Is Considered a Windfall?

There’s no precise definition of what constitutes a financial windfall. An unanticipated $250 could be a windfall for a student on a low income, for instance. The amount you consider a windfall will depend on your financial situation and perceptions.

What to Do With a Financial Windfall

Before giving in to the temptation to spend your windfall impulsively, take some time to think through the wisest uses for your newfound cash. Stashing the money in a high-yield savings account can help you maximize interest earnings while you decide what to do with your windfall.

Depending on the source and size of your windfall, here are some options to consider:

• Plan for any tax bills: Inheritances, prizes, or winnings and gains from selling property or stocks may be subject to federal, state, and local income taxes, and possibly estate taxes or capital gains taxes. A tax adviser can help you determine how much you’ll owe and what to set aside.
• Pay down high-interest debt: With the average annual percentage rate (APR) on credit card balances topping 20% in 2023, paying off credit card debt can mean significant savings. By lowering your credit utilization ratio, paying down high-interest debt could also boost your credit score.
• Start or build your emergency fund: Experts advise having at least three to six months’ worth of essential living expenses set aside in a savings account earmarked for emergencies.
• Increase contributions to tax-advantaged retirement accounts: You’ll not only build your nest egg but also reduce your taxable income, potentially balancing out taxes owed on your windfall.
• Create a sinking fund: Save for big goals, from a family vacation or a new car to a down payment on a home, by putting money into a dedicated savings account.
• Save for your children’s education: Consider opening a 529 savings plan to set money aside for their college funds.
• Invest the money: If you’ve maxed out your retirement plan contributions, consider expanding into stocks, bonds, real estate, and other investment vehicles to create additional wealth.
• Make a budget: A life-altering financial windfall can lead to lifestyle creep, where you start overspending without even noticing. Developing a budget can help you determine the best uses of your money.
• Consider working with a financial professional: A financial advisor can help you minimize taxes on a large windfall and create a plan for using the money to achieve your financial goals.
• Revise your estate plan (or make one): A major financial windfall can make it easier to provide for your loved ones after your death. Create an estate plan to reflect your new financial situation; consider purchasing more life insurance too.

The Bottom Line

It’s easy to see how a windfall of hundreds of thousands of dollars can change your life. But a windfall of any size can have a lasting impact on your finances, depending on how you use it. Having good credit makes a difference too. While reviewing your finances in the wake of a windfall, be sure to check your credit report. Then take steps to improve your credit score if necessary—for example, by using your unexpected windfall to pay down debt.

For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with confidence and expertise.

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