What would you do if you woke up tomorrow with an extra $10,000? What about $100,000 or even more?

While visions of tropical vacations or that long-awaited kitchen renovation might spring to mind, take a step back. With some planning, a cash windfall can become a tool for building long-term wealth and financial security.

By making smart decisions now about what to do with a windfall, you can feel confident that your money will serve you and your family well for years to come. Here’s how to make the most of a sudden windfall.

What is a windfall?

A windfall is a significant amount of money a person receives, often unexpectedly. There’s no magic dollar amount – it could be a few hundred dollars, or it could be millions. Any money big enough to change your financial situation is a windfall.

When many of us think of winning the lottery or receiving an inheritance when we hear “windfall,” people experience windfalls in other ways as well, including:

• Settling lawsuits or insurance claims
• Selling real estate or a business
• Getting a bonus or having another sudden income change
• Receiving a retirement lump sum payout

Steps for managing a windfall wisely

No matter where your windfall of money comes from, keeping these steps in mind can help make it last for you and your family.

Take your time

It’s generally a good idea not to rush when deciding what to do with a financial windfall. You might feel the urge to make an extravagant purchase, like a home, car, or vacation, or put it all into paying off outstanding debt. While none of these ideas are inherently bad or good, consider all your options before choosing how to handle your windfall.

Keep it quiet (at least at first)

Depending on the size of your windfall, be selective about whom you tell and how much detail you give. Not only does experiencing a sudden windfall have the potential to change your life, but it could also affect your relationships with friends, family, and others.

Get professional advice

A large windfall of money could have major implications for your finances. Inheritances, lottery winnings, and proceeds from selling property are often subject to certain federal and state taxes. Plus, you’ll likely owe more in income tax – especially if your increased income moves you into a higher tax bracket. You may also be required to follow special rules if your windfall includes non-cash assets, like stocks and bonds.

Your best bet is to consult a financial planner, accountant, attorney, or other professional. These experts can help you understand how your windfall may affect your overall financial picture and can help protect you from unwanted tax surprises.

You may also consider consulting an estate planning expert to determine if you need a will and help you create one. Learn more about end-of-life planning.

Deciding what to do with your windfall

Once you’ve consulted the experts and covered any tax obligations, the fun part begins deciding what to do with all that money.

It’s a personal decision, to be sure – but there are many ways to save, spend, and invest your windfall so that the money works hard for you long-term.

Build up savings and reduce debt

According to the Federal Reserve Board’s 2022 Economic Well-Being of U.S. Households, almost 4 in 10 Americans can’t cover a $400 emergency expense. To avoid being one of them, consider using your windfall to start an emergency fund or add to one you already have. A good rule of thumb is to set aside up to six months of living expenses in a checking or savings account.

After you’ve created a savings cushion, think about paying down any unsecured debt you’re carrying, like credit cards, student loans, and medical bills. Pay down debts with the highest interest rates first, then work your way down from there. These steps will go a long way toward setting you up for greater financial freedom.

Invest for retirement

Next, start thinking about your future. Investing part of your windfall can grow the value of your money over time, giving your family an extra financial cushion as you age.

While you can’t invest money from your windfall directly into a 401(k), which your employer funds through payroll deductions, there are other ways to use your windfall to boost your retirement savings. Remember that different retirement savings strategies have different tax implications and advantages. To figure out which approach is right for your goals, consult a professional for advice.

Invest in an individual retirement account (IRA)

If you don’t already have an IRA, this could be the perfect time to open one. A bonus: The IRS has increased the maximum contribution amount for 2023 to $6,500 (and if you’re age 50 or older, you can contribute up to $7,500). Be aware, however, that other factors may limit how much you can contribute to a Roth IRA.

Offset bigger 401(k) contributions with windfall money

As of 2023, the IRS allows up to $22,500 in 401(k) contributions from money you earn from your job. With a cash windfall at your disposal, you could consider increasing the amount of money your employer deducts from your paycheck and invests in your 401(k). Then, you can offset what was taken from your paycheck with money from your windfall and use it to cover normal expenses.

While this approach is a bit more complex, you can invest for retirement beyond the $6,500 annual limit on IRA contributions. You could also receive greater tax benefits and take full advantage of any matching 401(k) contributions your employer may offer. Before making any changes, check with your employer about how much money you can invest.

Explore stocks and other investments

If you’ve maxed out your options for tax-advantaged options, you can still potentially grow your windfall through stocks, bonds, or other investments. Plenty of companies make it easy to set up your online portfolio, but if you’re new to investing or want expert advice, consider working with a financial advisor. To ensure their interests align with yours, consider whether a fee-only or commission-based advisor is appropriate for your needs.