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Received a Lump Sum of Money? Here's What You Might Want to Do Next

Received a large sum of money? After you finish celebrating, now what? Let's walk through a few options.

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This story originally appeared on MarketBeat

Did you receive a lump sum of money from a deceased relative? Maybe you're all set to receive a wad of cash from a parent or grandparent around the holidays. Or maybe you're planning to get a larger-than-usual bonus from your boss at year end. 

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Windfalls are more common than you may think, and Americans get them through a variety of methods — through an inheritance, lawsuit settlement, bonus and even the lottery. According to Schwab, Americans plan to leave an average of $177,000 to their relatives when they die. About 35% of working-age Americans receive an average of $24,000 from family members in gift money.

Once you receive a lump sum of money, what do you do with it? Invest it as a lump sum or invest in increments over time? Spend half of it and invest the rest? Let's walk though your options.

What Options Do You Have for a Lump Sum?

What might you choose to do when you receive a lump sum of money? Some options might include paying down debt, building your emergency fund, investing, fund your retirement accounts, funding an HSA and more. Let's walk through each option.

Pay Down Debt

You may want to direct your attention to your looming debt — a mortgage, a couple of car loans, maybe a personal loan and student loans. If you have debt, you're not alone. 

In fact, total household debt rose by $313 billion (2.1%) to reach $14.96 trillion in the second quarter of 2021, according to the latest Quarterly Report on Household Debt and Credit from the Federal Reserve Bank of New York. Mortgage balances rose by $282 billion and auto loans increased by $33 billion. Credit card balances increased by $17 billion, according to the same report.

You may see the value in paying off any high-interest consumer debt like credit cards. Doing so can benefit you in more ways than one: You can save on interest and also eliminate any possible negative impact on your credit score. 

Build Your Emergency Fund

Building an emergency fund might seem like really boring uses of windfall money. Building your emergency fund, however, can give you the peace of mind you need so you have money at your disposal if something comes up — the car conks out, you must have an emergency surgery, you lose your job, etc. 

The bottom line: You want to have between three and six months' worth of expenses in an emergency fund. You might want to cushion your emergency fund with more money if, for example, you own your own business and make irregular income. 

Invest Your Money

Investing your windfall is often a natural choice. But should invest all your money at once or invest it in smaller increments over time, a strategy called dollar-cost averaging? Dollar-cost averaging allows you to avoid volatility on large investments right away. Dollar-cost averaging might work best for you if you want to minimize the downside risk of a huge investment or take advantage of the market's natural fluctuations by only buying when the market dips. Taking the dollar-cost averaging approach can help you feel better about investing right when the market takes a swing downward. 

Investing a lump sum, on the other hand, gives you exposure to the markets right away so you can take advantage of market growth immediately. You put time on your side so your money can grow.

A Northwestern Mutual study found that between an immediate lump-sum investment and dollar-cost averaging, the lump-sum investing outperformed dollar-cost averaging 75% of the time. In fact, a 100% fixed income portfolio outperformed dollar-cost averaging 90% of the time. You may want to consider this study before you choose one option over the other.

Fund Your Retirement Accounts

What's going on with your retirement fund these days? Is it plumped to the max? You can invest $19,500 in 2021 in employer-sponsored plans such as a 401(k), 403(b), 457 plans or a thrift savings plan. You can invest an additional $6,500 if you're 50 or older.

You can contribute $6,000 to an individual retirement account (IRA) or Roth IRA with a catch-up provision of $1,000 for individuals 50 and older.

As long as you're earning income, you may be able to put extra money here. 

Fund an HSA

Have you ever considered using a health savings account (HSA) to fund your retirement? You can do so as long as you invest in a high-deductible health plan.

HSAs offer a three-pronged tax benefit: 

  • Contributions are tax-deductible.
  • Earnings grow tax-free.
  • Withdrawals are tax free as long as you use them for medical expenses.

It's a great retirement savings vehicle because you'll probably need to spend money on medical expenses in retirement.

Put the Money Aside for Now

Here's an unconventional thought. Instead of doing something with your money right away, you might want to set it aside so you can think about what to do with your cash. You can put it in a short-term account (such as a savings account or money market account) while you decide what to do. It might even help you figure out whether it's a wise choice to spend part of it or not.

Talk to a Fiduciary Financial Advisor and/or a Tax Advisor

A fiduciary financial advisor can help you figure out how to handle a large amount of money based on your goals, risk tolerance and investment timeline/horizon. A financial advisor can also help you carefully figure out the right asset allocation for your investments based on all of those factors.

You may want to get a CPA or tax advisor involved because you'll need to pay taxes on part of your windfall through capital gains taxes or estate taxes. 

Make the Right Decisions for Your Lump Sum

Notice that one other option didn't make the list, though it's certainly an option: You can spend all of your windfall (or a portion of it). 

Spending a portion of it may make sense if you've got all your debts paid off and if you have your retirement funds squared away. If you've made the right decisions financially, you might want to take that trip to Tahiti or build the home of your dreams. However, just be aware of the tax implications before you get started.