Windfall ideas based on your life stage

Whether you’ve earned a bonus at work, or received an inheritance, it can be easy to get carried away when you get a windfall. But, while there’s certainly no harm in treating you and your loved ones a little, it’s worth coming up with a plan for the bulk of your cash.

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Invested wisely, it’s value will be amplified over the years and it could stand to make a very significant difference to your future financial security. Here, we take a look at some of your options, whatever stage of life you are at.

Young adults

It might not be terribly exciting but an emergency fund is crucial to your financial security. Think of it as a cushion if you face a surprise bill, lose your job or your circumstances change. Money in the bank means you don’t have to rack up expensive debt.

If you’ve already got debts such as credit cards it’s worth clearing them too – unless they are interest-free and you’ve got a bit of breathing space. You might also have a student loan you want to be rid of too but, however much that might appeal, there’s often a better use of your cash over the long term.

The most obvious is to use your windfall to help you buy your first home. Although your lender will still take student loan repayments into account when you apply for a mortgage, it won’t affect your credit rating in the same way as other types of borrowing.

If your windfall isn’t quite enough to give you that first step on the property ladder, if you’re aged between 18 and 40 you might be tempted by a Lifetime individual savings account (LISA). Contributions are limited to £4,000 a year (part of your overall ISA allowance of £20,000), although you do get a 25% bonus from the government, worth up to £1,000 a year.

There is, however, a maximum home value of £450,000, which it’s important to factor in if you plan to buy in a pricey urban area.

If you’ve already bought a home and you’ve got enough stashed away for an emergency, a stocks and shares ISA can be an ideal home for your windfall and help shore up your finances for midlife.

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Each year you can invest up to £20,000 in ISAs and your money will grow tax free.

Returns will vary according to how your investments perform but, if we assume a mid-range average return of 5% a year, a one-off investment of £20,000 would be worth £32,940 (before charges) after 10 years, £42,274 after 15 years – more than doubling its original value – or reaching £54,253 if you manage to leave it untouched for 20 years.

Midlife and pre-retirement

The financial challenges don’t stop in midlife – if you have children, you’ll have quickly discovered that they don’t get cheaper with age. You might find yourself needing to spend money on a bigger home or renovate an existing one to comfortably accommodate you all.

And even when children leave home the costs don’t necessarily stop if they’ve headed to university.

It can be an expensive time of life, but even if you’re approaching peak earnings, the financial pressures of this stage of life, might mean you aren’t saving as much as you should for your own future.

A windfall can therefore be a godsend for your pension – increasing both the tax-free cash and retirement income you’ll eventually be able to take from it. The real benefit of this approach is your contribution will be boosted by tax-relief, equivalent to the rate of income tax that you pay. You just need to be mindful of allowances if you are paying in a lump sum; each year you can invest 100% of your earnings up to a maximum of £60,000.

However, if your windfall means you can pay in more, you might be able to increase your contribution by using carry forward rules. These allow you to use any unused pension allowance from the previous three years, the catch is that you need to have earned at least the amount you want to contribute, in the current year.

But your pension isn’t the only sensible option – especially if you are still a way off retirement and might need to access your money before the age of 55 (rising to 57 in 2028).

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A stocks and shares ISA could again be a sensible option. If you’ve a larger windfall, bear in mind that married couples will have £40,000 they can shelter from tax each year. Although you don’t get the benefit of tax relief on your contributions, you won’t pay any tax on it when you take it out either and, while you should ideally be investing for at least five or 10 years, you can access your money whenever you want if you need it.

If you have the option, you can spread your windfall across pensions and ISAs. However, if your windfall is large and you are also investing outside pensions and ISAs, you will need to keep an eye on capital gains tax (CGT). The annual exemption for CGT is now just £3,000 a year, which means you’ll need to regularly review your gains and take steps to manage them to spare yourself a tax bill further down the line.

One approach, is to do a so-called Bed and ISA, drip-feeding gains from an investment account into a stocks and shares ISA – so long as you have enough remaining allowance for the year.

Retirement

If you’re already retired, a windfall such as an inheritance can be a real blessing. You can use it to increase your income or spend it on luxuries you might not otherwise be able to afford. Alternatively, if you don’t need the income, you might decide to save it and leave the money to pass on to younger generations when you die.

However, it’s a bit more complicated if you don’t necessarily need the money and have an inheritance tax liability brewing. Die without spending the money and your windfall will only increase the value of your estate and the tax bill your loved ones will pay.

In these cases giving away money before you die is a potential solution and it means your loved ones should get the full value of their inheritance, without the tax man taking a slice.

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But how feasible this is will depend on your age, state of health and amount you need to give away. This is because gifts are subject to a sliding rate of inheritance tax (IHT), with the amount payable decreasing the longer you live after making it, until you reach seven years and the gift becomes IHT free.

However, there are some ways around the seven-year rule. For example, each year everyone can give away up to £3,000 a year tax free and if you didn’t use your allowance last year, you can also carry it forward to this year, meaning you could give up to £6,000 in one go (or £12,000 between a couple).  There are also special rules around gifts for weddings:  you can give £5,000 to a child that is getting married, £2,500 to a grandchild or great-grandchild, or £1,000 for anyone else.

But if you are older and received a large windfall, it might be difficult to give it away without incurring an IHT bill – especially if you are suffering with your health and unlikely to live seven years. However, there could still be an option. A deed of variation allows you to change the will in a way that allows you to redirect your inheritance to a new beneficiary – such as a child or grandchild. The new beneficiaries don’t need to have been named in the original will. The deed of variation must, however, happen within two years of the person’s death.

Changing a will through a deed of variation is reasonably straightforward. However, if this is a route you are considering, it’s worth getting legal advice.