’Windfall gains’ – the word itself brings a spark in the eyes. This article is about options that one has for utilizing the windfall, and how to make the most out of it. It also highlights pitfalls to avoid while deciding on using the windfall.
What is ‘Windfall Gain’?
Windfall Gain is money received in a lump-sum like from winning a lottery/contest, gambling, insurance maturity pay-out, gain from speculation, business, bonus, arrears, inheritance, stock sale, provident fund withdrawal, gratuity etc.
Windfall gain can be expected (like arrears, PF withdrawal, bonus, insurance maturity pay-out etc.) or unexpected (like winning a lottery/contest, gambling, gain from speculation etc.)
- General tendency is to spend or invest the windfall immediately – in a jiffy. This is the biggest mistake and one is sure to repent if one doesn’t plan out the utilization.
- There are certain windfalls that are tax-free like inheritance, insurance maturity, PF withdrawal, gratuity (to some extent) etc. however, there are quite a few that generate a tax liability like winning lottery, arrears, bonus, business etc. It is important to know the tax liability and consider the ‘Net’ windfall gains only. Not making provisions for taxes would haunt oneself towards end of financial year.
What to do?
- Plan – Take time out to plan on spending vs investing the proceeds. Do not make any decision in haste.
- Temporary parking of fund – It is important to park the fund in some safe and liquid option. Idea is to reap returns on the fund while one plans out the spending and investing. Many a times the fund keep lying in Savings Bank account which fetches anywhere between 4% to 7% currently (depending on bank). Though 7% is a good return but it is taxable and if one falls in high tax bracket (say 30%) then the post-tax return comes down to around 4.9%. Instead it is better to park these funds in liquid funds that are currently churning out a return of around 7% post tax – the difference is huge.
- Make provisions for taxes – Find out the tax liability and the time by when tax need to be paid. TDS might have been deducted during the pay-out. Take that into consideration while making provisions for taxes.
- Spending vs. Investing – The most important aspect when planning is to determine the percentage of windfall that one should be spending vs investing. One can use the following guidelines to arrive at this
- Repayment of high interest debt – Preference should be given to repaying high interest debt. The highest interest debt is the credit card dues followed closely by personal loans. Ensure that these are brought down to ‘0’ as soon as possible. These are the biggest drag on one’s finances with annual interest rates upto a whopping 50% (it is not possible to find an investment yielding return of this magnitude which is safe) and shall help one save a decent amount every month – so one can reap the benefits of the windfall monthly. Is there a better option than this? There could be other loans that one could prepay like vehicle, EMIs on household items etc. On the other hand, one can continue to service some loans like home loan or education loan – as these provide some tax benefits – bringing down the effective rate.
- Invest in self – One might be waiting for completing a certificate, enrolling for a class that can give one a promotion or some technical course that shall help start one’s own venture. Fund any of these with the windfall. Investing in skill upgrade is the best investment as the benefits are reaped for all the time to come.
- Goals – Find out whether one has been saving enough for the goals. Is there any goal that one is yet to start saving for? Windfall gives an individual a great opportunity to address any shortfall in the financial plan – in one shot.
- Re-balance portfolio – Windfall can also be utilized to adjust the skew in asset allocation. Suppose one’s asset allocation is skewed too much in favor of debt than the proceeds can be invested in equity to re-balance the asset allocation.
- Acquire asset to create additional revenue stream – Identify an asset that shall create additional revenue stream for future like acquire a property that shall generate rental income while also appreciating in value, tax-free bonds that shall generate annual income for years to come or the like.
- Treat oneself – Only after one has considered all above aspects should one look at things that one always wanted to do – a vacation to an exotic location, a house renovation, a gadget or anything.
If one has a strong compulsion to splurge (after all we are humans ), think of the bad financial times – if one has been lucky to not have experienced a bad financial time, then think of some friend/relative who have had one.
By following the tips mentioned above, one is in for a pleasant time ahead and shall keep reaping benefits of one-time windfall for all the times to come.