Have you recently received extra cash from an inheritance, career shift, tax refund, or work bonus? If so, you may wonder how you can make impactful money decisions with that lump sum. Most families find deciding the best way to use the extra funds challenging, especially when they have many financial commitments.
One of the best things you can do when you find yourself with a lump sum of money is to hire a financial coach like The Draper Group. A financial coach will help you make informed decisions about your finances and ensure that you use your money in the way that will suit you best. Today we’ll explore some of the best ways to handle large sums of money, so let’s get started!
Here’s What You Can Do With A Lump Sum of Money
Before you do anything, talk to your tax professional and investment advisor. Your financial coach can help you dig through their advice to find the right path forward for you.
You can shift your money story and mindset upon receiving a lump sum. This journey can include paying off debt, building up your emergency fund, investing, contributing to your retirement accounts, and funding a health savings account (HSA). Let’s examine each option in more detail, so you feel empowered the next time money comes your way.
Reduce Your Debt
You are not alone if you have outstanding debt, such as mortgages or car, personal, and student loans. In fact, according to the Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit, total household debt in the US rose by $351 billion (2.2%) to reach $16.51 trillion in the third quarter of 2022. This report also showed that mortgage balances increased by $282 billion, auto loan balances rose by $33 billion, and credit card balances increased by $17 billion.
Paying off high-interest consumer debt, like credit cards, can benefit you and your family in multiple ways. Not only can you save on interest payments, but you can also avoid any potential negative impact on your credit score.
Create an Emergency Fund
While it might not be the most exciting use of extra cash, building an emergency fund can provide you with peace of mind and financial security in the event of unexpected expenses. Whether your car breaks down, you need to undergo emergency surgery, or you lose your job, having an emergency fund can give you the financial flexibility to handle these unpredictable situations.
Generally, it’s best to have three to six months’ worth of expenses saved in your emergency fund. If you are self-employed, have an irregular income, or have dependents, consider having a larger emergency fund to cushion any potential financial inconsistencies.
Invest the Money
When investing money, you can invest the entire sum at once or in smaller increments over time, a strategy known as dollar-cost averaging. Dollar-cost averaging can mitigate the risk of significant investments by allowing you to take advantage of market fluctuations and purchase when prices dip. This approach may be beneficial to minimize an investment’s potential downside risk.
On the other hand, immediately investing your lump sum allows you to take advantage of market growth from the start and benefit from the power of compound interest. According to a Northwestern Mutual study, a lump-sum investment outperformed dollar-cost averaging 75% of the time, and a 100% fixed income portfolio outperformed dollar-cost averaging 90% of the time. While this study is worth considering, it is ultimately up to you to decide which roadmap aligns with your wealth plan and what this money’s purpose will serve in your and your family’s lives.
Always talk to a tax professional to understand your tax implications before investing.
Fund Retirement Accounts
Consider contributing to your retirement accounts if you have received a lump sum. In 2023, you can invest up to $22,500 in employer-sponsored plans, such as 401(k)s, 403(b)s, 457 plans, or thrift savings plans. If you are 50 or older, you can contribute an additional $7,500.
Additionally, you can contribute up to $6,500 to an individual retirement account (IRA) or Roth IRA, with a catch-up provision of $1,000 for individuals 50 and over. As long as you earn income, you can contribute extra funds to your retirement accounts to help secure your financial future. Consider allocating additional earnings towards your retirement savings to ensure you’re prepared for your future.
Income limits may apply to your retirement contributions. Taxes may apply to your lump sum. Ensure you work with your accountant and tax professional any time you invest.
Fund an HSA
Use a health savings account (HSA) as a retirement saving tool if you have a high-deductible health plan. HSAs offer a triple tax benefit, as contributions are tax-deductible, earnings grow tax-free, and withdrawals for medical expenses are tax-free.
As with anything involving health insurance, ensure you are working with an independent health insurance broker. Ensure you also talk to your financial advisor and tax professional to understand your options.
Forget the Money Temporarily
If you’re unsure what to do with your windfall immediately, guessing is not the right strategy. Consider setting the money aside in a high-yield savings or money market account while you make a decision. Putting the money in an interest-bearing savings account can give you time to consider your options and talk to your financial coach to determine your best course of action. Remember, there are lots of right answers. It’s essential to find the right solution for you.
Moreover, holding onto the funds temporarily means you can also avoid making impulsive decisions and ensure that you make a wise choice. Whether it’s saving, investing, or spending a portion of the funds, taking the time to consider your options carefully can help you make the most of your earnings.
Contact a Professional
If you have received a large sum of money and are trying to figure out how to handle it, a financial coach will provide guidance and support. A financial coach will help you build a roadmap that ensures you feel confident driving this transition.
In addition to seeking the advice of a financial coach, consider consulting with a certified public accountant (CPA) or tax advisor. Receiving a lump sum of money can be a blessing. Still, even in these moments of abundance, we should look to professionals to guarantee all tax rules and regulations are followed and that our responsibilities are understood.
In conclusion, receiving a lump sum of money can be an exciting and overwhelming experience. By considering your options for paying off debt, building an emergency fund, investing, contributing to your retirement accounts, or funding a health savings account, you can make the most of your extra money and set yourself and your family up for financial success. Always remember there is no “right” answer, only the correct one for you.
If you are seeking additional guidance on managing your lump sum of money, consider hiring The Draper Group. Receiving a lump sum is an incredible opportunity that, with the proper guidance, can drastically improve your life’s path.
What is the best thing to do with a lump sum of money?
The best thing to do with a lump sum of money depends on your financial goals, risk tolerance, and financial situation. Start by talking to your financial advisor and tax professional; you may owe taxes immediately. Consider paying off high-interest debt, building an emergency fund, investing long-term, contributing to your retirement accounts, or funding a health savings account. It is essential to carefully evaluate your options and make a plan that aligns with your financial priorities. A financial coach can help you sort through your questions to find the correct answer for you.