What’s a Windfall?

First of all, what is a windfall? The terminology stems from a fruit falling off a tree. Often described as dropping during a strong wind.  The symbolism is applied as a person receiving a sum of money unexpectedly, often amidst a period of turmoil in their life.

Much like Sir Isaac Newton getting hit in the head with an apple leading him to the laws of motion, a windfall can be, well, fruitful #dadjoke.  It can also be difficult to navigate, and end poorly if you’re not careful. A windfall could be the result of an award, gambling/lottery winning, sweepstakes, inheritance, insurance or death benefit, lucky investment, sale of a business, or even a gift, plus many other smaller instances.

I write this article as an experienced recipient of a small windfall that helped spark an interest in personal finance in me.  I’ve researched this topic for years and collected my thoughts on the do’s and don’ts when you find yourself on the receiving end of any amount of cash.

*This post may contain affiliate links, meaning that I receive a small commission at no extra cost to you when you make a purchase through these links. Thank you!*

The First Pitfall

Most people only consider windfalls as a “life changing amount of money” or a “large sum” but that’s not always true. Depending on the circumstances $1 may be life changing. Did the tooth fairy help mold your perspective on money growing up? Mouthful of loose teeth = potentially your first windfall.  And with that influx of newfound wealth comes the first pitfall, the temptation to spend it.

This is exactly the behavior that you see when people receive bonuses from work, tax refunds, and nowadays stimulus checks.  “I have x amount of dollars, what can I get with that?” Shopping sprees, lifestyle creep, unusually expensive meals, and financing something that they deserve.

How many times have you heard someone say that they’ve put their tax return down on something?  That’s even worse. They took all the funds that they let the government borrow for 0% interest, then turned them around into instant debt.

Not only do people commonly fall into this trap. They don’t learn their lesson. They’ll spend it over and over again. Stimulus money is given out to stimulate the economy. It works so well because the gov’t knows that most people are going to spend it. Whether that’s on things they actually need or just want.

The Lottery Winner Syndrome

Now you’re saying “Fill, sure I could easily blow a few thousand dollars (every year) but if I won a million dollars, I would be much more responsible with *most* of it.” Well look at the statistics for lottery winners, something like 70% end up piddling it all away! Just google “lottery winners end up poor” it’s a trip. The truth is, you’re actually more likely to be reasonable with a smaller windfall. Like when you use your paycheck to pay your rent or mortgage and bills every month, high five!

Your monthlies are part of your budget. Your budget is part of your long-term financial plan. Receiving a windfall shouldn’t change your method or plan at all. If anything it should just jump you forward through a few steps in the FIRE flowchart (updated to version 4.3 link dated October 2023).  I don’t even suggest it bumps you into immediate retirement at any amount, but more on that later.

This is the root of the argument that “the rich keep getting richer while the poor keep getting poorer.” The example set here is that the poor lottery winner ends up poor again. However, this isn’t a result of any direct targeting by the rich, this is the result of a poor financial literacy setting the winner up for failure. Poor people with a rich financial literacy get and stay rich all the time. Rich people with a poor financial literacy become poor all the time too.

Interestingly enough, it takes no money to learn on your own how to have a rich financial literacy.  Even better if you can teach it to others, like your kids, for generational wealth. It would have been nice if parents and schools taught this stuff, but then again you’ll only retain what knowledge is in line with your goals.

Becoming a Target

The next real pitfall of receiving a windfall is that now you may show up on other’s radars as having money. This could be creditors, family members, friends, new gold-digging acquaintances, phony business partners, you name it. The beggar on the street corner is asking anyone and everyone for money but the smarter con artists are asking the people with “excessive” money. Google windfall and one of the first results at the time of writing this article is a service to identify individuals with high net worths as targets for donations!

This one is easily avoidable by resisting the urge to brag and staying the course. Bragging can be in the form of telling people with words in the most literal form. It can also be shown by ridiculous spending actions; cars, clothes, jewelry, vacations etc. So you won a million dollars? If someone asks, just say it was “mostly eaten up by taxes,” or “went into paying off some debt,” blah blah blah. Or my favorite answer that instantly bores everyone “I invested it into low cost index funds” with two thumbs up. No one else really needs to see or know what you do with it. Except maybe your trusted financial planner if you aren’t confident enough to take this on yourself.

In my research I also came across some murder mysteries and conspiracy theories. Stories of one spouse offing the other for the insurance payout. So even your potential windfall could make you a target, but don’t become paranoid. There’s no need to worry about this unless you don’t trust the people in your financial life. Moral of the story, surround yourself with good people.

The Best First Step Advice

Back to the question of “would you retire immediately if you received a life changing amount of money?” I’m about to share with you the number one tip for anyone receiving a windfall of any kind! The absolute best advice I found from the collective internet is to PAUSE.

If cash, take the sum and drop it into a high interest savings account for a few months up to a year. If investments, transfer into accounts under your ownership properly and let them sit. I know that I preach the old saying “It’s not about timing the market, it’s about time in the market” but a few months of some money you didn’t plan to have anyway remaining out of reach shouldn’t make or break your long term plans.

This is an extended version of the buyer’s remorse avoidance technique of: if you want something, wait five days and see if you still want it.  Take this time to learn about money.  Grow your rich financial literacy. Ponder what you could do with it.  Research how to manage it.  Calculate the effect it has on your net worth and financial plans. Understand the value you could bring to your life to optimize not only your new or future wealth but your past and existing financial habits too. 

Most importantly, continue on with your regular life to maintain some semblance of consistency and avoid lifestyle creep.  This is especially crucial if your windfall was part of a loss in your family.  Take some time to heal. Making massive financial decisions are not done best when in a hurry or with emotion.

Build Your Financial Literacy

As I mentioned before, it’s free to build your financial literacy.  It takes nothing but time and interest to research for the answers, just like any good DIY project. Although, finding the time and interest in such a boring subject can be tough. Sometimes it takes a windfall to open your eyes to the possibilities, scare you a little, and force you to get interested.

There seems to be a trend that the older you get combined with the more responsibilities you have, the more interested you become in money and your future. For example, twenty year old me was like “what’s a four hundred and one k? No thanks I want my money” then thirty year old me was like “man I wish I would have been maxing out all of these tax advantaged accounts since day one!”

No matter what age or circumstance, a windfall is a great time to research, consider, and interview any potentially trusted financial experts to add to your team. Can you handle this on your own? Or will some hired help be required?

I’m all about the DIY approach but I’m also so interested in personal finance that I started this entire blog about it. You may need guidance. Ask me, keep reading, join our email list for future blog posts (over on the right hand side of the page), and request specific topics through the contact form!

Tax Considerations

Usually when a large sum of money shows up at your door, uncle Sam shows up too wanting his cut too.  Depending on how your windfall came about and where you live the tax laws are very different. In general, assume there will be some taxes paid on some of it somewhere.

For inherited investments (transferred into accounts in your name) maybe even let them sit over a year to move into the much lower long term capital gains tax brackets if/when you decide to sell. On any sweepstakes, lottery, or gambling winnings – get ready to pay taxes as regular income. For gifts, the giver may be required to file another gift tax form but for the receiver its usually tax free.  

Also be aware of required minimum distributions (RMDs) on inherited IRAs, calculated off the age of the original account holder. Figuring out and taking the RMD is a good way to avoid the 5 year rule if you plan on keeping them invested where they are for continued tax sheltered growth. RMDs are taxed as normal income.

Note that the IRS makes the rules but doesn’t tell you the numbers here. Most good brokerages will give you guidance, but they always come with a disclaimer that you should be doing the math to doublecheck for yourself. Ultimately, you’re accountable for the record keeping of how exactly you’re following the rules.

After the Waiting Period

Now that you’ve weathered the storm and gotten a plan together, it’s time to act.  Your plan should include a small celebration to help get that ‘lottery winner syndrome’ urge out of your system.

While most internet advice will state a hard and fast rule of spending 10% frivolously, to me in most cases that seems excessive. Maybe 10% should be the very upper limit of how much of your windfall you can drop on a whim. Again, this is after you’ve researched and calculated how this money can work for you long term, so you may be able to drop that spending off to 0% fairly easily.

This is the same methodology I encourage others to try at their salaried jobs when they get a raise. If you didn’t have that money before and were making ends meet, then any new higher income can just go straight to debt payoff, savings, or investment for FIRE (financial independence retire early).  Same story for a windfall, you didn’t have it before so in theory 100% of it can go towards your financial journey without ever passing through the temptation of your checking account.

The Legacy

It’s entirely in your hands how to utilize any windfall of ANY size that you receive. I hope this post forces you to think differently about stimulus checks, bonuses, tax refunds, gifts, and your long term goals. Whether you consider your next paycheck a small windfall or not, take this opportunity to follow along and build a rich financial literacy while creating a value filled life.