Four beneficial ways to handle a financial windfall

Receiving a large financial windfall may make you feel much more confident about the future.

A financial windfall might come in the form of:

• Selling your business
• Earning a bonus at work
• Receiving an inheritance
  • Benefiting from a divorce or separation settlement
• Winning the lottery.

After all, whether you’re still in your career years or approaching retirement, a sudden influx of capital could mean you have a wider range of opportunities in the future.

Yet of course, as the old adage goes, with great power comes great responsibility. Knowing how to handle a windfall – and more specifically, how to use it to work towards your life goals – is crucial.

With this in mind, let’s take a look at four different ways you could use a financial windfall, and how each one could help you pursue your specific life goals.

1. Build your emergency fund

If you’re looking to increase your financial security, one simple way to put a financial windfall to good use would be to build up your emergency fund.

Typically, we recommend that our clients have three- to six-months’ expenses saved in cash for emergencies. Credit Connect reports that the average UK household spends a little more than £2,000 a month on essentials – so an average emergency fund of between £6,000 and £12,000 may be suitable.

Your emergency fund is crucial for covering costs like:

• Your mortgage
• Car payments
• Insurance
• Home repairs
• Food and other basics.

For instance, if you were unable to work for a short period of time, your emergency fund could help to prevent financial stress by covering the basics you need.

If you received a financial windfall and don’t have an emergency fund, this could be your first port of call.

2. Top up your pension

As of the 2024/25 tax year, most earners can have total pension funding, including employer contributions, of up to £60,000 a year (including tax relief) without receiving an additional tax charge. This is known as the Annual Allowance.

Your Annual Allowance could be lower than £60,000 if:

• Your adjusted income is more than £260,000 a year and your threshold income is above £200,000. In this case, you may be subject to the Tapered Annual Allowance, which could bring the amount down to a minimum of £10,000.
• You have already flexibly accessed your pension. This means you may have triggered the Money Purchase Annual Allowance (MPAA), which brings your Annual Allowance for money purchase pension funding down to £10,000.

Your own tax-relievable contributions are capped at 100% of your earnings in the tax year of payment of the contribution (or £3,600 a year if more).

So, you may be able to contribute a generous amount into your pension and benefit from additional tax relief when you do.

If you benefit from a windfall and are unsure where best to place the funds, your pension could be a tax-efficient place to consider.

This is especially important in light of the rising cost of living.

Figures from the Pension and Lifetime Savings Association (PLSA) show that for a couple, the cost of a comfortable retirement has gone up to £59,000 a year – meaning a 25-year retirement could cost nearly £1.5 million for you and your spouse.

With these figures in mind, it is no surprise more than half of over-40s are “anxious about retiring”, according to a study published by FTAdviser in 2023.

Moreover, it may be worth considering using your windfall to top up your and your spouse’s pensions in time for retirement. This additional cushioning could help to see you through a comfortable retirement for as long as you both live.

3. Pay off your mortgage

If you have an outstanding mortgage on your family’s home, it may feel like a no-brainer to pay off this debt after receiving a lump sum.

Indeed, financial reporter states that between Q4 2021 and Q4 2023, more than 1 million people have taken out mortgages that would see them past State Pension Age – a situation that nobody wants to find themselves in.

If you are approaching the end of your career with a mortgage still in tow, using a windfall to pay down some or all of this debt could:

• Lower your outgoings in retirement
• Secure more equity in your home
• Offer immense peace of mind.

However, it is important to discuss this move with a professional before you proceed.

For example, you could be met with early exit fees if you attempt to pay off your entire mortgage at once. In this case, it may be better to increase your monthly payments to the maximum amount possible and pay off your debt this way.

In any case, talking to a Financial Planner might help you to decide if this move is right for you.

4. Give the money to the next generation

If you feel confident about your retirement prospects and are not in need of additional funds, you could worry about how a windfall may add to your family’s Inheritance Tax (IHT) bill.

We’ve talked previously about how you could have an IHT issue you aren’t aware of, because the nil-rate bands, under which no IHT is due, have been frozen until 2028.

Because of this freeze, HMRC saw an increase of £400 million in IHT receipts for the 2023/24 tax year when compared to the previous year. This means that while the value of your estate rises – such as, if you received a financial windfall – a larger portion of it may be dragged into the taxable bracket.

As such, it could be wise to consider giving some or all of the funds you receive to the next generation.

Yet giving away the entire lump sum at once could also cause tax issues later on; we’ve written an article about how “giving while living” could be more suitable for tax purposes.

Passing these funds on to your children and grandchildren could:

• Enable them to achieve their life goals more easily
• Offer them greater financial stability
• Reduce the IHT liability on your estate.

Once again, it could be very useful to discuss your IHT mitigation strategy with a Financial Planner before giving a large sum to the next generation.

Get in touch with us to learn more about putting a windfall to good use

Our experienced Financial Planners can help you to make the most of a financial windfall.

Email us at enquiries@pen-life.co.uk, or call 01904 661140.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only. All information is correct at the time of writing and is subject to change in the future.

All contents are based on our understanding of HMRC legislation, which is subject to change.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

The Financial Conduct Authority does not regulate estate planning or tax planning.