What Is A Financial Windfall And How Can You Use It To Pay Down Balances
It’s a common tale we’ve all heard - some unsuspecting individual wins the lottery only to spend their entire winnings on a lavish lifestyle, eventually leaving themselves with nothing a short time later. The same can happen with inheritance and settlement money. The point is, many people don’t know how to spend their financial windfall money wisely.
What Is A Windfall?
A windfall refers to an unexpected and sudden change in one’s fortune. It’s usually used in reference to financial gain due to unexpected and fortuitous circumstances. The term comes from old English and was used by farmers to describe a piece of ripe fruit that had been lodged free from its tree by the wind.
Examples Of Windfalls
While the most common example of financial windfall would be lottery winnings, several other situations would fall under this category as well.
- Inheritance: Some people receive some type of inheritance, but not everyone is fortunate enough to receive a life-changing amount. For those that do, it would be considered a financial windfall
- Game Show/Casino Winnings: Everyone has seen shows like ‘Who Wants To Be A Millionaire’ and ‘Jeopardy’. Those who win the grand prize will be receiving a financial windfall. This is also true of those who win a large amount of money on a casino slot machine or blackjack table
- Tax Rebate: Not all financial windfalls are worth millions of dollars; some windfalls, such as tax rebate checks, can be a few thousand dollars
How To Use Windfalls
Financial windfalls can be life-changing events, but only if they are used wisely. Unfortunately, far too many people use their newly found wealth irresponsibly and end up with little or nothing left.
Pay Off High-Interest Debt First
The first thing any financially responsible person should do with their financial windfall is to pay off their high-interest debts.
These types of debts can be particularly damaging to an individual’s long term financial well being simply because of how expensive they are.
For example, consider something as common as a credit card with a $5,000 balance and a 21.21% APR. If the cardholder was to make only the minimum payment, typically 2% of the card balance, it would take them nearly 30 years to pay off the debt. Over these 30 years, they would incur a total cost of just over $21,000, not including any yearly account fees the card may carry.
Those who carry multiple high-interest debts stand to pay large sums of money in interest over the long term. Because of this, the financially prudent thing to do with one’s financial windfall is to eliminate all high-interest debts.
Add To Your Emergency Fund
An emergency fund isn’t quite the same as savings. Savings is money that one puts away for their future, whether it be for the purchase of a house or retirement. An emergency fund is money that’s put aside for managing a temporary financial crisis such as the sudden loss of one’s employment or an unexpected medical emergency that requires expensive treatment or a hospital stay.
Even if one’s financial windfall is a large amount, it’s still wise to set aside some funds specifically dedicated to an emergency. People who win the lottery or inherit a large sum of money tend to spend without restraint. Having an emergency fund ensures that one always has some money accessible in case of an emergency.
Add Money To Your Retirement Accounts
Most Americans simply don’t save enough for retirement. They underestimate how much they’ll be required to spend on medical expenses and overestimate how far their social security check will go. How one lives, and the level of comfort they enjoy, in their later years shares a causal relationship with how much they have saved in their retirement account.
Whether it be a 401k, IRA, Roth 401k, or simply a high-interest savings account, a decent portion of one’s financial windfall must be put towards their retirement.
Pay Off Other Debts
Once high-interest debts have been paid off and some money has been put towards one’s emergency and retirement funds, it’s time to look at retiring other debts. Some debts, such as mortgages, HELOCs, lines of credit, and other forms of secured debt carry lower interest rates than credit cards. While they may not cost as much over the course of a decade, the interest still adds up. If an individual has the funds available to pay off their debts it’s usually the best course of action.
A financial windfall can be a life-changing event. It can help people pay off their debts, secure their retirement, and allow them to enjoy aspects of life they may never have thought possible. That being said, many people spend their newly acquired fortune on frivolous items and a lavish lifestyle, only to be left in a worse situation than where they started. Accordingly, think twice before spending an entire windfall if you’re the fortunate recipient of one.