Making the Most of Windfall Income
Year-end bonuses. Tax refunds. Sale of assets or investments. Inheritance or other unforeseen gifts.
Not all financial surprises are bad ones. While we need to plan for unexpected expenses through savings, we also need to plan for windfall income in order to maximize its effectiveness. Windfall income occurs when we receive a one-time influx of funds. Sometimes, we can predict when we’ll have a windfall but maybe not the exact amount (annual bonuses, tax refunds, etc.). Sometimes we may be able to predict the amount we’ll receive (selling investments or other assets). Other times, we may receive income unexpectedly (inheritance, unforeseen gift, etc.).
While we shouldn’t presume on the future by counting on windfall income to help us meet our budget, planning in advance for the possibility of windfalls can help us make wise decisions with extra income.
Ideas for Windfall Income
Giving. Windfalls, like all income, are ultimately a gift from God – regardless of what we may have done to earn them. As a result, we should consider returning a portion of them to God as an expression of our gratitude. Making this decision in advance can protect us from the temptation to use all the income for our own desires.
Saving. After giving, the next thing to consider is saving. Here are a few questions to guide your thoughts on saving from windfall income:
- Do you have an Emergency Fund set up with at least $1000?
- Do you have consumer debt (non-mortgage debt) to retire?
- How close is your Emergency Fund to 3 months’ worth of expenses?
Spending. Are there any priority expenses or items you need to purchase that don’t fit into your monthly budget? Examples might include vacation, car, appliances, etc. The key guideline here is whether an item has been on your “list” for a while, or whether it’s a spur-of-the-moment purchase. If it’s the latter, you may find yourself with buyer’s remorse a short time down the road.
How it works
Suppose I have the following:
- Emergency fund with $7,000 in it (and $3,000 per month expenses to cover)
- Credit card debt of $1,000
- An appliance that needs to be replaced (research has determined a cost of $700)
- Plans for a vacation estimated to cost $2000.
- A car that will need replacing in a couple of years.
For the sake of this example, let’s say I prioritize use of windfall income as follows:
- Giving (10% of the income)
- $1,000 to retire credit card debt
- $2,000 for vacation (assuming it’s an important vacation)
- $700 to replace the appliance
- $2,000 to finish out the Emergency Fund
- Remainder to go to the car savings fund.
If I get a tax refund of, say, $3500, I’ll use it as follows:
- $350 for giving
- $1,000 to pay off the credit card
- $2,000 set aside for the vacation
- $150 saved toward the $700 appliance.
This example is not meant to dictate your specific priorities. Everyone’s situation is different – maybe the appliance needs replacing quickly and should be taken care of before the vacation. Perhaps the car will need replacing sooner rather than later and may need to be prioritized over adding to the Emergency fund. The point is that pre-determining priorities for windfall income can help us to make the best use of that income rather than wasting much of it on spur-of-the-moment spending.