Getting a windfall — an unexpected financial gain — comes with a lot of questions. You may have student loan debt or credit card debt to repay, or want to set money aside for the future, but don’t know where to start or best use this influx of cash. Here is a hypothetical situation to help you understand what your best bets may be for dealing with a windfall.
Lisa recently inherited $100,000 from her grandmother. She has an outstanding credit balance of $5,000, which she accumulated while she was in between jobs last year. She has $50,000 in student loans (half federal, half private) and $1,000 in her checking account. She just started contributing to her new employer’s 403B, the 401K equivalent for non-profits.
How can Lisa use this windfall wisely?
1. Attack High-Interest Debts
Lisa has just been paying the minimum on her plastic. In one swoop, she can fully pay off her outstanding credit card balance of $5,000 and still have money left over. Assuming she was being charged 20% in interest on the card, she would save about $6,000 by not having to pay interest payments to her credit card company. (You can use this credit card payoff calculator to find out how much you may save by paying off your credit card debt.)
She can also make a huge dent on her student loan debt, by paying off the higher-interest private student loan ($25,000). If she thinks she will work for a nonprofit for at least 10 years, she doesn’t have to accelerate paying off her federal student loans. She can instead consider applying for Public Service Loan Forgiveness Program, which will cancel her remaining federal student loan debt after 10 years.
2. Stay Liquid
Lisa should consider keeping at least $15,000 in the bank, which will serve as her emergency fund. This will help her avoid getting back into debt if she’s in a bind. She could place it in a high-yielding online savings account, which may give her a 1% interest rate.
She may also want to place $30,000 in a high-quality bond fund, in case she would like to buy a house four or five years down the road. A typical U.S. bond index fund currently generates a 2% yield, and thus can help grow her money two times faster than a savings account.
3. Max Out Roth Contributions
Lisa can now open and contribute the maximum amount to a Roth IRA (currently $5,500), possibly for the next three years. This will allow her investments to grow tax-free. She can also consider investing in a target-date fund. In certain situations, you can withdraw contributions to a Roth without penalty, so this could serve as an additional source of money for emergencies if needed.
4. Take a Vacation
Hang out at a beach in the Caribbean? Hike Machu Picchu? Indulge in the wonderful scenery of New Zealand? Wherever it is, I think she should take advantage of this windfall by treating herself and a friend or family member to a relaxing (or adventurous) vacation. (I don’t think Lisa would mind me telling her that, either!)
5. Give to a Good Cause
This is an excellent time for Lisa to support a cause that is important to her. Whether it’s helping refugees from Syria, hungry children or victims of natural disaster, there are lots of people who could benefit from her donations. She may not even need to look beyond her city. She can use websites like Charity Navigator that rate charities on their level of effectiveness to make sure she feels good about where her money is going.
Paying off her debts will not only help Lisa alleviate some stress, but can also contribute to improving her credit score. If you’re like Lisa and want to see how the financial changes you’re making are affecting your credit, you can view your free credit report summary, updated monthly, on Credit.com.
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