When you get a year-end bonus or another financial windfall, it may be tempting to splurge on an expensive vacation or shopping spree — and while it’s totally OK to enjoy some of this money, you should also think about how you can use it to help your future self as well.
To find out some of the best uses for a financial windfall, GOBankingRates spoke with Crawford “Mickey” McGill, a certified financial planner with Ameriprise Financial who works with many professional athletes. These pros often receive large salaries after years of being paid nothing at the amateur level, and McGill has coached them through how to best use this newfound wealth. After all, windfalls can be hugely beneficial, but only when managed correctly.
Here’s what McGill says to do with a financial windfall.
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Take Taxes Into Account
Before making any moves with your windfall, you need to figure out your tax liability.
“Finding out how the money was paid is the most important part of figuring out your tax liability on a financial windfall,” McGill said. “Can it be considered business income or is it personal income? Were there taxes withheld and how will the money be reported to the IRS? Understanding how the money is earned will help with which direction to take the deduction. If the money is business income, then you may be able to take business expenses from the income. If the money is personal income or what’s called W-2 income, then you may be more limited on deductions.”
If you do owe taxes, find out if you can either defer or deduct the tax liability.
“Deferring taxes make sense if your taxes liability will be less in the future versus today,” McGill said. “It is not always possible to defer certain types of income. Checking with a CPA can help determine the type of income received.”
“Looking at tax deduction is the next step,” he continued. “Finding deductible expenses for the income is the goal. There may even be ways to get a tax deduction now for a cash gift given to a charity in later years. The last step is to [look] into tax-advantaged investments when possible.”
Think About Your Future Self Before Making Any Decisions
“Always ask if your future self would approve of your decisions today,” McGill said. “It’s a fine line between ‘you only live once’ and bankrupting your future. Giving yourself permission to enjoy your life today is important, but not to the detriment of your future.”
Take a look at your budget and financial plans before deciding what to do with your windfall.
“Your future financial goals will determine how much you get to enjoy today,” McGill said. “The bigger the goal, the larger the investment today. It’s possible to enjoy yourself today and take care of your future needs, but it will take discipline and determination.”
Remember That Your Windfall Is Finite
Just as your windfall is a one-time influx of funds, athletes know that their higher salary won’t be forever. In this sense, think of your windfall as an athlete would think about their seven- or eight-figure salary.
McGill advises athletes to “think about the life you want to live today and budget for it. Pay yourself an allowance from your salary and stick to that amount. Things normally go off track when we splurge and go off-budget.”
In the case of a financial windfall, you should also give yourself an “allowance” and save or invest the rest. As McGill notes, “it’s hard to spend what’s already gone.”
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Reevaluate Your Risk Tolerance
If you invest some or all of your windfall, you may want to rebalance your risk if your funds are not needed immediately, with a plan to reevaluate in the future
“It will depend on the timeframe of when you think you will need the money and your risk tolerance,” McGill said. “The longer the time horizon, the more risk you can add in.”
Be Smart When Choosing Investments
“Always understand the risks involved in any investment before you get into it,” McGill said. “Spend the time to learn about whatever you’re investing your money in. If it’s a business, be involved in the business and show up to learn more. You can have people help with the running of the business, but it ultimately falls to the [individual] to make sure they know what’s going on.”
Be OK Saying ‘No’
When you come into a large sum of money, people may come out of the woodwork asking for favors or investments in their personal projects. But just as he advises athletes, McGill says it’s important to know when to say “no.”
“Saying no is about empowering you, not hurting the other person,” he said. “Athletes are pulled in many different directions, and taking a step back and making sure they are making the best decision is the most important activity they can do for themselves. When you have a lot of money that you never had before, a lot of people tell you what’s best for you that don’t always know your full situation. Slowing down and learning what is best for yourself will empower you to make a better decision. The average person can learn from this financially and personally. Saying no to overextending yourself can lead to a happier life.”