When a Windfall Lands

If You Choose the Wrong Strategy You Could Blow It

Cindy Drimmel just inherited $80,000 from her grandmother, and while she welcomes the money, she finds the options for using it overwhelming. Should she pay off her credit cards or her mortgage? Save more for retirement or pay off a car loan? Replace her roof or invest in a certificate of deposit?

"I knew I wanted to properly invest it, because that's what my grandma would have wanted, but I didn't know where to start," says Drimmell, a 23-year-old from Grand Rapids, Mich. "You get a thousand opinions, but how can you tell who's right?"

Financial windfalls come in many forms: a year-end bonus, a tax refund or even a winning lottery ticket. But for many people, figuring out what to do when an unexpected sum of money falls in their lap -- whether it's a few hundred or a few hundred thousand dollars -- is no easy call.

Popular options for handling a lump sum include paying down debt and buying a house, but those choices carry their own trade-offs, financial experts say. The experts recommend that recipients thoroughly review their own finances and completely understand the tax implications of a windfall before deciding what to do with the money.

No matter how you use a windfall, planners say it should have a long-term benefit, such as getting out of debt or saving for retirement. Don't blow it all on a new car or on items that could get you deeper in debt, like starting home renovations, which are notorious for costing more than anticipated.

"All it takes is for one thing to go wrong for things to turn bad very quickly," says Mary Malgoire, a financial planner in Bethesda.

Look in the Mirror

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Financial experts say that making the most of a windfall starts with knowing your financial personality: Do you hoard money or spend too freely, or in amounts beyond your income? An honest assessment is essential, Malgoire says.

"It doesn't mean you have to accept who you are. You can change," she said. "But you have to be honest before you can change anything."

Recipients also need to know what taxes might be owed on the lump sum. You don't want a surprise tax bill, especially one you haven't set money aside for, says Anne L. Stone, a tax lawyer in McLean. She suggests contacting whoever sent the check -- the executor of a will or the state lottery office, for example -- to make sure.

When it comes to an inheritance, in Maryland and the District, a deceased person can typically pass on $1 million to a non-spouse before his or her estate has to pay a state transfer tax. The limit is $2 million before federal taxes kick in. In Virginia the limit is $2 million, the same as the federal cap, before a state transfer tax is incurred.

But income tax could be owed on money above or below those limits if it is interest earned on money held while an estate attorney figured out how to contact you. If the estate paid the tax on the interest, you won't owe it. If it didn't and instead passed the earned interest along to you, you might, Stone says.

Finally, recipients should analyze their income and spending to know where their money goes every month, from mortgage payments to lunch, financial planners say. That cash-flow analysis should also include a tally of all outstanding debts.