How to best use a financial windfall
By Mike Brown
Sometimes, dreams come true. You hit the lottery, find out your old comic book collection is worth a fortune, receive a bequest from a long-lost aunt, or otherwise step into a five- or six-figure windfall. Your first impulse may be to go on a wild spending spree, but on more sober reflection, you might decide to use the money as constructively as possible. Here are some smart ways to use your windfall:
- Set up emergency fund: Financial analysts generally recommend you salt away three-to-six months of living expenses in a rainy-day fund, in case your employment or health situation changes. This is not an investment fund, but rather risk-free savings such as a CD or Treasury
- Pay down debt: Get rid of your highest-interest debt right away. This is usually credit-card debt, but also could involve a personal loan or even a payday loan. You can then put a dent into longer-term debt, such as your mortgage or unpaid student loans. Paying down debt makes you more creditworthy, with means your credit score should go up and you’ll be eligible for lower-interest credit cards and loans.
- Buy a home Do you want to own a home? A large windfall might allow you to put down at least 20 percent on a house purchase, which means you can save thousands by avoiding private mortgage insurance. The more you put down, the less income you have to show, and the less interest you’ll pay. Buying a home not only boosts your lifestyle, it also lets you deduct mortgage interest and cut your tax bill.
- Refinance an existing mortgage: If you are paying more than 6 percent on a mortgage but have shied away from refinancing because of the origination fees, now’s the time to fix the problem. You can probably save tens of thousands over the life of mortgage by lowering your rate by 2 percentage points. Use the windfall to pay the refinance’s closing costs and you’ll be saving money every month thereafter.
- Make a big-ticket purchase: Rather than finance a new car, wedding or cruise, you might be able to pay cash and avoid interest expenses. With the exception of mortgages, interest is not deductible. Rather than pay 5, 10 or 20 percent interest on a big-ticket purchase, simply fork over the cash, avoid interest charges and sleep well at night.
- Establish a credit history: It’s possible you’ll receive a chunk of money and yet have no credit history or a low credit score. You can use some of your windfall to establish or spruce up your credit report. For example, you can take out a secured loan or secured credit card and pay it off over the course of six months. This should boost your credit score, making it easier to access credit and to pay less for debt.
- Open a retirement account: You can open an IRA and contribute $5,500 a year ($6,500 if you are 50 or older). If you’re married, that’s up to $13,000 a year. Better yet, if you are self-employed, open a personal 401(k) account and sock away $58,000 a year. Added bonus: contributions to these accounts are tax-deductible.
- Fund a trust: Parents and grandparents might want to set up one or more trust accounts for their children and grandkids. You can leverage the windfall in several ways. For example, you can set up a trust funded by an insurance policy, or one that skips a generation.
Windfalls don’t happen very often, so think long and hard about how to maximize its value. A solid plan will save you the regret you’d feel from frittering the money away.
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