Pennies from heaven. It's a problem everyone would like to have but, when it happens, it's still a problem nonetheless.
Coming into money -- whether from a tax refund, an inheritance or, more rarely, some kind of prize winnings -- is a welcome turn of events. But how many horror stories have you heard of a windfall gone awry?
"I had a customer win a legal settlement and he was awarded $500,000," said Christopher Gibas, a certified financial planner and president of the Financial Planning Association of Western New York. "Despite my advice, he blew through the money within five months, purchasing a new Corvette, fancy vacations, a lakefront home and even got loans against the amount. He declared bankruptcy less than a year later."
To avoid what he calls such "ego centered" purchases, Michael Hardy, a CFP with Mollot & Hardy in Amherst, suggests windfall recipients sit on their money for three months while they brainstorm its best uses.
"People have a tendency to treat money that was not earned with less respect than money they worked hard for," he said.
Consumers interviewed by MoneySmart were surprisingly conservative with their imagined windfalls. When asked how they would spend a windfall of $5,000, $25,000, $100,000 or $1 million, most stated practical moves such as paying off bills, setting money aside or starting a business.
But even such simple moves can be tricky.
Though specifics will vary wildly from case to case, here is some advice from local financial planners, should you be so lucky:
>Paying Off Debt
Getting rid of bills is often the most popular choice when it comes to a windfall, and a smart one at that. But there are certain ways to go about it, according to those in the financial know.
A lot of people told MoneySmart they would pay off their house with a large windfall. But that might not be the smartest use of your money, especially if you have a low interest rate mortgage. If you're able to pay your mortgage each month with your current income, there are probably other things in your life that could use your money more, such as your savings, retirement and high-interest debt. Another reason to resist paying off the house might be the tax deductions brought about by paying mortgage interest.
"Paying off one's mortgage or any form of tax-efficient debt is a personal preference. We work with clients who prefer not to have debt, period," said William H. Kelly, a certified financial planner and senior vice president of the BKSG Group at Harold C. Brown & Co. "On the other hand . . . some of our clients would choose to [use the tax benefit and invest the extra money]."
Another rule of thumb, depending on the size of a windfall, is to prioritize paying off consumer debts that have the highest interest rates. That might take the form of credit cards, store accounts and car loans.
You've probably heard several times that you should have an emergency fund set aside that would cover six months of your living expenses. And if you still haven't been able to do that, that's a good place for your windfall.
"There is an emotional tendency to pay off all debt, but if you haven't saved any money, you could easily end up there again when the roof starts to leak, the refrigerator breaks or the car dies," said Michael Birenbach, a CFP and president and chief compliance officer of Orchestral Financial Group in Amherst.
In fact, whether the windfall is $5,000 or$1 million, Birenbach suggests putting at least half the money away in savings.
Another seemingly smart but snap judgment would be to sock it all away in a long-term retirement account, such as a 401(k). But a better choice might be to put some money in a money market account or savings account for easy access, should you need the money sooner.
When it comes to big paydays, your go-to team of advisers should include a certified financial planner, an accountant and an estate planning attorney, according to Stanley Lichwala, a CFP with Wells Fargo and president-elect of the Financial Planning Association of Western New York.
Once debt is paid off and savings are established, financial planners suggest making investments that expect short- and medium-term payoffs (such as certificates of deposit, U.S. Savings Bonds and mutual funds) and long-term payoffs such as retirement accounts.
If you qualify for a Roth IRA, both you and your spouse should contribute $5,000 apiece to one. You should also max out any retirement contributions that are matched by your employer if you aren't doing that already.
If you have children and plan to help pay for their college education, contributing to a 529 savings plan would be another good idea.
When it comes to splurging, every financial planner said it is an important thing to do -- but probably not as important or in as great a quantity as you might think.
"All you do is work and then you die," joked Birenbach. "You've gotta smell some roses. You have to breathe a little bit."
That being said, no one said anything about jetting off to Hawaii while your credit card bills sit in a drawer, burning up interest at 20 percent.
"I'd rather see someone reward themselves after they've mastered the art of building wealth," said Birenbach.
A rule of thumb is to splurge small, splurge when it is affordable and avoid splurging on things that depreciate in value, such as cars, trips and meals.
After all, planners remind us, wealthy people don't get and stay wealthy by splurging. They get and stay that way by spending less than they earn, then saving the rest.
"I'd love to see someone splurge after they've really earned the splurge, and not a minute sooner," said Birenbach. "No matter how big the windfall, you'll end up back in the hole if you have a habit of splurging."