From bonuses and inheritances to redundancy packages and prize wins, there are several reasons why you might have the fortune to come into a lump sum of money.
But while any form of winning is always going to be welcome, it can cause a minor headache too. Knowing what to do with it and how to manage it present its own challenges. Used wisely, however, it can have a long lasting impact on your finances. Here are six things to consider as you work out how to invest a one-off sum of money.
Top up your emergency fund
Investing should be for at least five years, so it’s important to have some form of cash buffer that you can draw on for any short-term needs and emergency outgoings. A windfall is a great opportunity to put a safety net in place or strengthen your existing protection, giving you invaluable peace of mind. Lump sums of up to £85,000 in savings accounts, bonds and cash ISAs are protected by the Financial Services Compensation Scheme.
Your emergency fund should be equivalent to between three and six months’ worth of outgoings, and should be held in an easy-access account – separate from your current account. If you have expensive debts to repay, however, these should be the priority. Also make sure you clear any debts before you think about what else to do with your lump sum.
Avoid the tax pitfalls
There are a few potential tax issues to be aware of when you’re saving and investing large amounts of money. One is the personal savings allowance (PSA), which allows taxpayers to earn £1,000 in interest (£500 for higher- and additional-rate taxpayers) before paying tax on it.
That might sound like a high threshold, but a Freedom of Information request by AJ Bell found that one in 15 taxpayers is expected to pay tax on their savings in the current tax year. So, make sure you take full advantage of your £20,000 annual ISA allowance. If you have children in the family it might also be a good chance to put some money into a Junior ISA for them.
Go for growth
While cash savings have their place to cover planned expenses in the next five years, that money is at the mercy of inflation. This is why it’s so important to use stock market-based investments as well. While you may worry about the risk involved, we know that while markets go up and down, stock market-based investments typically beat inflation over the long run. We answer some questions you might have on choosing investments.
If you’re new to investing, most investment platforms offer plenty of information, guides, tools and calculators that can help you get started. Our own website carries a vast range of articles, and you can also use our free comparison tools to find the best investment platform for you. If your windfall is a significant one, you may find that even if you already invest through a platform, a different platform may now be better for your needs.
Diversify your portfolio
You might be able to take more risk with a lump sum, but it’s still essential to select investments that suit your risk appetite and to diversify by spreading your money across different sectors, countries and asset classes. Also try to diversify again within each asset class and sector. Exactly how you diversify your investments will depend largely on factors including your age, circumstances, aims and appetite for risk.
Boost your pension
A lump sum is a great chance to turbo-charge your pension pot. There’s no ceiling on the amount you can pay into your pension and the tax will be the same as it is on a normal regular contribution. And remember that the sooner you can pay it in, the more time it will have to grow.
Pensions are a very tax-efficient way to save as pensions tax relief means it will cost you less than you might think to pay into your pension plan. Most basic rate taxpayers get a 20% tax top up on their contributions, while higher rate taxpayers get 40% tax relief and additional rate taxpayers an extra 5% on top of that (the income tax thresholds are different if you live in Scotland).
Just make sure the amount you put in doesn’t take you over the £60,000 annual allowance, above which you’ll face a tax charge. With pensions you can backdate unused allowances up to three years, which means you can carry forward three years of unused allowance in order to boost the amount of tax relief you get in a tax year.
Get advice and guidance
Whatever the amount you’re investing, it’s essential that your portfolio accurately reflects your appetite for risk and your long-term objectives. Advice is of great value here, while most investment platforms and fund supermarkets offer a range of tools to help you build, manage and easily keep track of your investment portfolio. Our free investment platform comparison tool will help you identify the best platform for you while also keeping your costs down.
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