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How to Manage a Financial Windfall

Citi's Women & Co.

This article, written by Stephanie Taylor Christensen, was originally published on Women & Co.

Many of us dream of an out-of-the-blue windfall of cash, but when it becomes a reality, we often don’t know what to do. How should you manage your financial gain? Whether it’s a few thousand dollars or significantly more, here’s some expert advice.

1. Account for tax implications.

Certified financial planner (CFP), Nancy D. Butler says that, regardless of the amount, it’s important that you understand how your windfall is taxed. Lottery or gambling winnings, for example, are taxable to you, while an inheritance may or may not be, depending on the state in which you and the deceased reside, their relationship to you, and the amount. “Set aside the amount of tax you’ll owe before you spend any of it,” she advises. “Even if taxes were withheld before you received the check, it was probably the amount required but not necessarily the amount you actually will owe.”

2. Realize guaranteed “returns.”

If you have debt and/or don’t have an emergency savings fund worth at least six months of your income, this should be the “first stop” in leveraging the value of your windfall, says Miranda Reiter, founder of She & Money financial planning. When you pay off debts that incur interest—including credit card balances, student loans, and auto loans — you’ll instantly save the money the debt is costing you, and you’ll enjoy a new sense of financial freedom.

It’s important that you understand how your windfall is taxed.

“Credit card debts tend to be especially damaging,” notes Reiter, “because they typically carry high interest rates and can pull credit scores down if balances are high.”

As your cash flow gradually improves, online services like Citi ® Financial Tools can help you create a new monthly budget so you can allocate various contributions to your short-and longer-term financial goals, including saving for future purchases to help make sure that you don’t find yourself back in credit card debt.

3. Look to the future.

Saving for retirement doesn’t offer immediate gratification, but Reiter says it’s especially critical for women, “We’re more vulnerable than men in this area because we tend to live longer (on average), and are more likely to be widowed.” She also explains that since women tend to work part time jobs more than men (26 percent vs. 13 percent, respectively, according to the Bureau of Labor Statistics), they may not be offered retirement benefits.

In 2014, you can “max out” a workplace-sponsored retirement account, like a 401(k), up to $17,500. (To do so, talk to your company’s benefits administrator about increasing the percentage of your salary that you contribute. You may want to consider keeping a portion of the windfall in your checking account to cover the higher payroll deduction.) Mark Donnelly, certified financial advisor at AEPG Wealth Strategies, explains why this strategy is so beneficial: You’ll decrease your taxable income (and tax bill) and increase the amount of your assets that will grow tax-deferred. In addition, you’ll benefit from the value of returns compounding over time. If there’s money left after you’ve maxed out your 401(k), don’t forget that you can also make the maximum contribution to a traditional IRA ($5,500 in 2014), or Roth IRA, if you’re eligible based on income. Though it may not be tax-deductible, you can still get tax-deferred growth on the investments.

4. Make a plan.

If you’ve still got some cash to invest, Paul Jacobs, CFP and chief investment officer at Palisades Hudson Financial Group in Atlanta, says to first consider how much of the windfall you may need to spend over the next five years. “Invest those funds conservatively, in either short-term bond mutual funds or money market funds. (Intermediate- and long-term bonds will drop in value more than short-term funds if interest rates rise.)

As for the funds you don’t need for a while? Jacobs suggests you invest them in a low-cost, diversified portfolio that’s rebalanced periodically, appropriate to your risk tolerance. The younger you are, the more risk you can generally afford to absorb.

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