A financial windfall can be a life-altering event. In some cases, it’s a moment of celebration – like a bonus for exceptional performance or a winning lottery ticket. In others, it’s a somber occasion – like inheritance after losing a loved one or a settlement following a legal battle.
Regardless of the source, windfall money exists outside of your normal paycheck, so it should be treated differently than ordinary income. The following steps will guide you through how to manage this unexpected sum so that it becomes the basis of your financial freedom rather than simply an excuse for a shopping spree.
Step 1: Plan for Taxes
When you first learn about your financial windfall, you may be thrilled to hear the large number and immediately begin to make plans based on that figure. However, most forms of income are subject to tax, so it is important to first estimate your liability so you can make better plans based on the final number you will receive.
Taxation of Bonuses
Bonuses are treated as “supplemental income” by the IRS and can be taxed using one of two methods. First, if your bonus is paid separately from ordinary income, you can owe a flat tax of 22% for the first $1 million of your bonus and 37% for any additional amount – plus Social Security and Medicare taxes. Second, your employer can add your bonus to your regular pay and withhold based on your normal tax bracket. In either case, it is important to note that some states also impose additional income tax on bonuses, like Alabama which taxes these funds at 5%.
Taxation of Lottery and Gambling Winnings
Lottery and gambling winnings are generally taxed as ordinary income. For winnings over $5,000, a flat 24% is generally withheld. However, your actual tax liability could be as high as 37% depending on the amount you won and your other income.
Taxation of Inheritance
In the U.S., the recipient of an estate does not generally owe taxes on the amount they receive. However, large estates owe tax prior to the distribution of assets. The threshold for taxability is $13,990,000 in 2025, or double that amount for married couples. You can learn more about estate tax in our article: The Basics of Estate Tax.
Taxation of Legal Settlements
If your windfall comes from a legal settlement, it is best to contact a qualified tax professional, as the taxation of these funds can vary widely. In general, income from legal settlements is subject to tax unless specifically exempted in the IRS code. Some of the most common exemptions are discrimination cases and payments for physical injury.
Once you understand the amount of tax you will owe on your windfall, you can begin to make plans to use it to secure your financial situation. This begins with evaluating, or re-evaluating, your goals.
Step 2: Define Your Overall Financial Goals
An influx of money can drastically shift your vision for the future, so it is wise to take a step back and think about what you want from life before making any decisions. As you do this, start with a general view of your future, then drill down and create specific, measurable goals.
Ask yourself, “what is important to you that money could allow you to achieve?” You may prioritize an early retirement or a break from a high-stress career. Alternatively, you may want to indulge in a higher standard of living. In either case, define what success looks like to you now that you have a stronger foundation from which to build.
As you redefine your financial goals, don’t forget to include legacy considerations. If providing for your children now or after your passing is important to you, include specific steps for this assistance in your goals.
Step 3: Determine The Most Effective Use of Funds
Once you know how much money you will receive and have a clear picture of your ideal future, it is time to make the difficult decisions that will bring your goals to fruition. Most people choose one of two paths – paying off debt or investing their windfall.
The Case for Eliminating Debt
Paying off debt, especially loans with high interest rates, pays psychological dividends. You eliminate a source of stress and can greatly reduce your monthly expenses – leading to a lower amount of income needed. This option generally appeals to people who are risk-averse, but it can leave the potential for investment gains on the table.
The Case for Investing
Another option is to invest your windfall. During your working years, this helps to grow your nest egg through compound returns, often leading to a much larger portfolio balance from which to draw income later. If you are planning to retire following your windfall, investments can generate the income that is needed to fund your lifestyle.
A Hybrid Approach
Many successful investors choose a blend of debt repayment and investing. They may pay off loans with interest rates that exceed the amount they could reasonably expect to earn in the markets – while investing the remainder of their funds.
The decision of how to allocate your windfall and which investments to choose is highly dependent on your personal financial situation, goals, and market conditions. An experienced financial advisor is the key to making this decision, as well as overseeing each step in the management of your financial windfall.
Make The Most of Your Windfall with Meld Financial
At Meld Financial, our team of tax, legal, and investment professionals specializes in helping clients make difficult decisions – like how to manage a financial windfall successfully. We work together to ensure that your new cash is integrated into your broader financial life, creating one seamless plan for your success.
Our process, called Financial Fingerprint®, is designed to be as unique as you are. It is a comprehensive financial plan that accounts for your specific tax situation, needs, and vision for the future. Best of all, this nimble plan adapts to your changing circumstances so that your financial decisions reflect your current goals and situation.
To learn more about Financial Fingerprint® and get started, contact a member of our team today.
