There are few dilemmas in life that are more pleasant than having to decide what to do with a lump sum of cash. Whether you obtained your windfall from an inheritance, winning the lottery or other contest or earned a bonus from your employer, you still have the same basic choices as to how the money can be used. You can either invest the proceeds, pay off debt or buy something with it, or some combination thereof. The best choice for you will depend upon your current circumstances and objectives.
If you decide to invest your lump sum, the best place to start may be with your retirement portfolio. If you do not have a Roth IRA or have not made your maximum contribution for the year, then consider doing so as your first step. If you face this choice between January 1 and the tax filing deadline, then you can also make a contribution for last year if you have not already done so. You might put the rest into a money market or other liquid fund and keep that as your emergency fund, or add the remaining balance to your existing cash reserve. (For more, see: Roth IRAs: Introduction.)
You could also purchase an annuity with the entire balance if you would like to shield all of it from taxation until retirement, as long as you won’t mind having to report all of your distributions from the contract as ordinary income. Purchasing a modified endowment contract (MEC) is another option that can give you an instant tax-free death benefit as well as taxable retirement income in one vehicle. You can also add accelerated benefit riders to the policy to provide coverage for critical, chronic or terminal illness. (For more, see: A Closer Look at Accelerated Benefit Riders.)
If you would like to keep your investment portfolio accessible before you reach retirement age, then you might look at one or more mutual funds or exchange-traded funds (ETFs) that fit your current objective, whether it be growth, income or tax efficiency. Stocks and ETFs will allow you to defer capital gains until you sell your holdings and may still provide some current income from dividends, depending upon the stock or fund you choose.
Paying Off Debt
If you are saddled with a large load of debt, then paying this off may be your best option. Financial experts maintain that it is possible to get 20% and 30% guaranteed returns on your money. All you have to do with it is pay off your credit card debt, and then you won’t be charged those outrageous rates of interest. If you have several debts to choose from, then you’re probably best off to start with the one that charges you the most interest and then pay off the one with the next highest interest rate and so on. (For more, see: Expert Tips for Cutting Credit Card Debt.)
Student loan debt and mortgage loans are generally considered to be the “best” types of debt because their interest is deductible, and the amount of interest that homeowners pay on their mortgages each year is often what enables them to itemize deductions and further reduce their tax bills. And if you use your funds to pay off other kinds of debt, you may be able to improve your credit score enough to refinance your home.
Buy a Big-Ticket Item
Although this choice is generally perceived to have the least return on capital out of the three broad categories from which you can choose here, this may be appropriate if you are currently in good shape with your debts and savings or else are going to have to purchase something big such as a house, car or other necessity. But in either case, you need to take some time to do your homework and negotiate the best possible deal for yourself. If you need to get a car, consider buying a reconditioned model that’s a couple of years old so that you don’t get soaked on the steep depreciation that plagues new cars. You may be wise to purchase a service package with that in order to minimize your maintenance expenses for the next few years. (For more, see: The Complete Guide to Buying a New Car.)
The Bottom Line
The best use for your lump sum depends upon you, your circumstances and what you would like to accomplish with your money. If you would like to play it safe with your funds, then paying off deb may be your best bet. If you need to beef up you savings, then you’ll need to make some investment choices. Buying a large item may also be justified if you either have to have that item in order to function or have your financial house far enough in order to be able to buy something recreational. Don’t hesitate to enlist professional help if you aren’t sure what to do here; this is a big opportunity for you, and you need to make the most of it. (For more, see: Do Big Inheritances Do More Harm Than Good?)