How to handle a windfall

Everyone dreams of coming into a sudden windfall of cash – that’s why so many of us play the lottery. But there’s a modicum of truth to the phrase “mo’ money, mo’ problems”. The reality of a sudden influx of cash can be very different from the dream.

Any windfall of cash – either through an over-performing investment, an inheritance, or a big win – comes with financial risk. There will be taxes to pay, decisions to make, and temptations to resist. Below we share a few suggestions to help you make the most of a windfall.

Take a moment

You may be tempted to splash the cash or make a long-wanted purchase, but before you spend any of your money, take a step back. Money has an extraordinary habit of disappearing if you aren’t careful with it. And there will be no shortage of people lining up to help you spend it…

If possible, keep your windfall to yourself for at least a few days, until the adrenaline has worn off and you get used to your new financial situation.

Look at your tax situation

Taxes are payable on all income – including unexpected windfalls. This could wipe out a significant percentage of the value of your windfall, depending on where you live and the amount of money you have. Many wealthy people have fallen into the taxation trap by treating £1 million (m) like £1m and then running out of cash to pay the taxman. Don’t make this mistake.

The source of your money will also dictate its real-world value and tax status. For instance, in the UK there is no tax paid on gambling winnings, but any inheritance over the value of £325,000 will be taxed at a flat rate of 40%. This means that gambling winnings of £1m will still be worth £1m after tax, whereas a £1m inheritance will come with a £270,000 tax bill, effectively reducing the value of your inheritance to £730,000.

If you are not sure what your new tax status is, seek professional advice.

Choose a short-term home for your money

It can be overwhelming to deal with the responsibility of managing a large amount of money suddenly. But you don’t have to become an expert high-net worth investor overnight.

Choose a safe home for your money where you can park it for a few months or even a few years while you decide how to handle it. Notice accounts – where you have to give 30 days notice or more before withdrawing your money – tend to offer slightly better interest rates than easy-access cash savings accounts. Fixed rate bonds are another good option, but your money could be locked away for several years.

Activate your imagination

Now that the initial rush has worn off and you have secured your money, its time to let your imagination run wild! Think about all the things you want to do with your money – the dream purchases, exotic holidays, country mansions and charitable donations. This is an opportunity for you to change your life, so take some time to fantasise, knowing that you now have the financial power to make your fantasies come true.

Follow these fantasies to their logical conclusion to work out how feasible they might be. For example, you may be able to afford to buy a private jet, but can you afford to staff it, maintain it, store it and fuel it? The reality may be slightly less glamorous (and slightly more expensive) than the daydream.

Spend or invest?

This is the big decision – do you spend your windfall, invest it, or do some combination of the two?

By now you should have a good idea what you want to do with your newfound wealth. But give it a little more thought. By investing just a portion of your windfall, you can secure your financial freedom for years to come. A £100,000 investment pot earning 4% per year will generate annual returns of £4,000. If these returns are reinvested and a 4% annual rate is maintained, within ten years that £100,000 would be worth £148,024.

The more you can invest, the more you can earn. However, that doesn’t mean that you can’t have any fun with your cash. Decide how much you want to spend, set that aside and then make a plan to invest the rest. Speak to a financial professional or do your own due diligence before creating an investment portfolio that matches your risk profile.

Giving your money away

Choosing to donate your money is an admirable thing, and it can actually be financially beneficial to you if you do it right. The UK allows Gift Aid to be paid on all charitable gifts – this means that the government will effectively waive any tax on your donation, so the charity gets even more money.

Charitable donations can also be counted as tax write-offs, allowing you to reduce your tax bill. And of course, there is the sense of satisfaction that you will get from supporting a local charity or a cause that is close to your heart.

Stay on top of your portfolio

You are now a wealthy individual with a substantial investment portfolio. All that remains is for you to keep an eye on your money and avoid any big losses. You can do this by diversifying your funds across a range of different investment types; by making use of tax-free wrappers to maximise your earnings; and by reinvesting any interest to benefit from the ‘compounding’ effect . Active portfolio management is the key to ensuring your long-term wealth, so that your windfall continues to take care of you year after year.