Did you receive a lump sum? Here’s what you might want to do next

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Did you receive a sum of money from a deceased relative? Maybe you are ready to receive a wad of cash from a parent or grandparent while on vacation. Or maybe you plan to get a bigger bonus than usual from your boss at the end of the year.

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Deals are more common than you might think, and Americans get them through a variety of methods – through inheritance, lawsuits, bonuses, and even the lottery. According to Schwab, Americans plan to leave an average of $ 177,000 to their loved ones when they die. About 35% of working-age Americans receive an average of $ 24,000 from family members in gift money.

Once you receive a lump sum of money, what do you do with it? Invest it in a lump sum or invest in increments over time? Spend half and invest the rest? Let’s go through your options.

What options do you have for a lump sum?

What might you choose to do when you receive a lump sum? Some options may include paying down debt, building your emergency fund, investing, funding your retirement accounts, funding an HSA, and more. Let’s go through each option.

Pay off the debt

You might want to draw your attention to your impending debt – a mortgage, a few car loans, maybe a personal loan, and student loans. If you are in debt, you are not alone.

In fact, total household debt increased by $ 313 billion (2.1%) to $ 14.96 trillion in the second quarter of 2021, according to the latest Quarterly Federal Household Debt and Credit Report. Reserve Bank of New York. Mortgage balances increased by $ 282 billion and auto loans increased by $ 33 billion. Credit card balances increased by $ 17 billion, according to the same report.

You can see the interest in paying off any high interest consumer debt like credit cards. This can benefit you in more than one way: you can save on interest and eliminate any possible negative impact on your credit score.

Build your emergency fund

Building an emergency fund can seem like a really boring use of windfall money. Building your emergency fund, however, can give you the peace of mind you need so that you have the cash on hand if something happens – the car stops, you need to have surgery. emergency, you lose your job, etc.

The bottom line: you want to have between three and six months of spending in an emergency fund. You may want to write off your emergency fund with more money if, for example, you own your own business and earn irregular income.

Invest your money

Investing your windfall is often a natural choice. But should you be investing all of your money at once or investing it in smaller increments over time, a strategy called averaging? The average cost in dollars allows you to immediately avoid the volatility of large investments. Average dollar costs may work best for you if you want to minimize the downside risk of a huge investment or take advantage of natural market fluctuations by buying only when the market plunges. Taking the dollar cost average approach can help you invest better when the market crashes.

Investing a lump sum, on the other hand, gives you immediate exposure to the markets, allowing you to immediately profit from market growth. You put time on your side so that your money can grow.

A Northwestern Mutual study found that between an immediate lump sum investment and an average dollar cost, the lump sum investment outperformed the dollar cost on average 75% of the time. In fact, a 100% fixed income portfolio has outperformed dollar cost on average 90% of the time. You may want to consider this study before choosing one option over another.

Fund your retirement accounts

What’s going on with your retirement fund these days? Is it plumped to the max? You can invest $ 19,500 in 2021 in employer-sponsored plans, such as a 401 (k), 403 (b), 457 plan, or a savings plan. You can invest an additional $ 6,500 if you are 50 or older.

You can contribute $ 6,000 to an Individual Retirement Account (IRA) or Roth IRA with a catch-up allowance of $ 1,000 for people 50 and over.

As long as you are earning an income, you may be able to put some extra money here.

Fund an HSA

Have you ever thought about using a Health Savings Account (HSA) to fund your retirement? You can do this as long as you invest in a high deductible health care plan.

HSAs offer a three-fold tax advantage:

  • Contributions are tax deductible.
  • Income increases tax free.
  • Withdrawals are tax free as long as you use them for medical expenses.

It’s a great retirement savings vehicle because you’ll likely need to spend some money on medical bills in retirement.

Put the money aside for now

Here is an unconventional thought. Instead of doing something with your money right away, you might want to put it aside so you can think about what to do with your money. You can put it in a short-term account (like a savings account or money market account) while you decide what to do. It might even help you determine if it’s a wise choice to spend some or not.

Speak to a fiduciary financial advisor and / or tax advisor

A fiduciary financial advisor can help you determine how to manage a large sum of money based on your goals, risk tolerance, and investment timeframe / horizon. A financial advisor can also help you carefully determine the right asset allocation for your investments based on all of these factors.

You may want to hire a CPA or tax advisor as you will have to pay taxes on a portion of your windfall gains through capital gains tax or inheritance tax.

Make the right decisions for your lump sum

Note that another option was not made on the list, although it is certainly an option: you can spend all of your winning (or part of it).

Spending some of it can make sense if you’ve paid off all of your debt and put your retirement funds to work. If you’ve made the right financial decisions, you might want to take that Tahiti trip or build your dream home. However, just be aware of the tax implications before you get started.

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