Most people would not complain about unexpected money coming their way, but knowing what to do with the money can pose an opportunity for some and a challenge for others. You may have received a large year-end bonus or even a significant monetary gift for the holidays. Perhaps you will be receiving a significant refund from your taxes in the next few months.
Do you have a plan for how you would manage your money in this situation? Before you find an influx of cash burning a hole in your pocket, consider these tips for responsibly managing unexpected money:
▪ Pause Before Spending. The first inclination you may have when you come into extra money is to spend it immediately. You may want to splurge on something you’ve been wanting or wish to funnel the money toward paying off debt. While neither of these options is bad, consider pausing before making any spending decisions. This gives you time to consider your options and how they could impact your current and future financial status.
▪ Put It Somewhere Safe. If a large bonus or refund is deposited into your checking account, the temptation may arise to spend more of it that you had planned. Putting the money somewhere safe, such as a savings account, can help reduce the temptation while you determine a plan for the money.
▪ Plan for Taxes. Depending on the type of windfall you receive, there may be tax implications to consider. Bonuses are considered income, which is taxable. You may want to speak with your employer, before receiving a bonus, about having a portion of it deferred into your retirement plan account which could limit your tax liability (depending upon the type of retirement account you have available).
▪ Consider Your Emergency Fund. Would you be in a financial bind if you suddenly lost your job or were faced with an unexpected expense? Having an emergency fund is recommended so you don’t become financially devastated if these events were to occur. Your emergency fund should be able to cover your monthly expenses for a period of time (3-6 months is typically recommended by most advisors). When you have your emergency fund in place, you will likely feel more comfortable spending, saving or investing money in other areas.
▪ Consider Your Debt. If you are carrying debt and the amount you receive is enough to pay off your debt, this may be a great option for you. If the amount covers some, but not all of your debt, you might consider paying down the debt with the highest interest rates first. You can then apply the amount you paid toward the higher interest debt to your remaining liabilities.
▪ Secure Your Future. For longer term savings goals, whether it be a new house or retirement, you should set aside money over time to achieve them. At a minimum, you should attempt to earmark ten percent of your gross earnings to support your retirement, and start as early as possible. Depending on how close you are to needing the funds to support your goals, you may consider saving a higher percentage.
▪ Confirm You Are Adequately Insured. Insurance needs will vary depending on your age, family situation, job, etc. Consider your personal situation and make sure you are appropriately insured.
▪ Treat Yourself. As long as your aren’t in a financial bind, taking some of the money to treat yourself or your family can be a fun experience. In fact, it might help ease some of the temptation to spend more than you should by giving you the opportunity to spend a responsible amount guilt-free. Whether you set aside an amount and spend it all at once, or spend a little each month, the freedom to reward yourself for what you’ve earned is a great feeling.
Working with a financial advisor can help you prioritize the options listed above, especially if the windfall you receive is life changing (such as a large inheritance or prize winnings). If you are already working with an advisor, talk to them about your increase in funds so you can work it into your financial plan. Remember, life is a balance between enjoying today and securing tomorrow.
The Money Matters column is written by members of the Financial Planning Association of Greater Kansas City. This week: Marc C. Shaffer, CFP®, AIF®, EA, a principal of Searcy Financial Services Inc., a registered investment advisory and financial planning firm in Overland Park. He currently serves as Chairman of the Board for the Financial Planning Association of Greater Kansas City. For additional information, visit www.SearcyFinancial.com.