FOOL'S EYE VIEW
What To Do With a Windfall

By Rob Davies
March 1, 2001

Carburton Street, London -- There you are, wending your weary way through life, just about balancing net income with gross habits, when KAZAM! A massive windfall drops into your lap. You know, serious wonga; say £100,000 or more. It might be from an inheritance, a demutualisation, a good bonus or a lottery win. But whatever it is, it is something that is completely outside your normal sphere of experience. You actually have more money than you know what to with.

So what do you do?

To some extent it depends on your personal circumstances, age and so on. But some things will apply across the board. The first thing is to do nothing. Do not sign up to the first, second or even third financial advisor that comes knocking on your door. With a bit of common sense it is perfectly possible for you to work out what you should do because it is simple. Follow the Foolish guidelines, keep control of your money and don't pay other people to do things you can do yourself.

1. Pay off Debt

The first step is to pay off all those debts, every single one. With a windfall you have absolutely no need to pay anybody to use their money. So: pay off the credit card, the store card, the car loan and the mortgage. Yes, the mortgage too. Paying off the mortgage gives you a guaranteed after-tax return of over 6% and, with the amount of money you are going to have, there is no way you can avoid paying tax. So this is a tax-efficient move. Paying off the mortgage eliminates worries about tax planning for the amount of money that would otherwise have to be invested. Remember, we are talking here about a windfall, something that is not going to be repeated. Owning your own home and not owing any money to anyone else should set you up for the rest of your life.

You may well want to move to a more expensive home as a result of the windfall. But the same rule should apply: pay cash.

2. Make a will

Suddenly you are wealthy and a lot of people will take a great deal of interest in you, and your health. Do you know who will benefit if you pop your clogs?  If not, make sure you do, and while you are at it start thinking about Inheritance Tax (IHT). You can give away £3,000 in any tax year without it being included in your estate for IHT purposes when you die.

3. Forget Life Insurance

With the amount of money you've got now the last thing you need to worry about is taking care of dependants after you've gone. You can either do that during your lifetime by making sure little Johnny has got enough to see him through university, or by making provisions in your will. You have made one by now, haven't you?   There is no need for you to pay for protection for people that don't need it.

4. Spend it

Yes, go on. Take that luxury holiday; buy a new sofa and the latest Skoda (they are desirable now you know). You can't take it with you, and it was your windfall, so enjoy it. Reducing the size of the pot makes investing easier and reduces the tax bill.

5. Give it away

After enjoying your hedonism you can salve your conscience by giving some money to a charity or deserving parts of the family, or me. Non-charitable donations of more than £3,000 a year in the seven years before you die will be included in the estate for IHT purposes, so do it sooner rather than later.

6. Invest it

After all that you still have stacks left over. And you want to make sure you never need to work again. Ah, well this is where it could get tricky, for reasons I'll explain shortly. But the good news is this. With a large windfall you don't need to worry about risk. You can, within reason, go for as much risk as you want and that means equities. In practical terms it means you can totally ignore all these so-called "safe investments" like with-profit bonds and endowment plans with high charges and opaque returns. Just walk straight past them because, with a windfall, you have a lot of money and you can afford not to worry about short-term market fluctuations. Besides, giving away even 1% of a windfall to an IFA or an insurance company is a big chunk of money. The percentage game gets very important with large numbers.

The simple thing to do with a windfall is to buy the mother and father of an index tracker and tick the box asking for dividends to be paid out to you. That way, with a low cost tracker, you will only pay 0.3% in annual charges and no front-end loading. That's a pretty efficient way of managing your money. You keep control and it needs no further input from you or anyone else. What could be easier?

However, there is a snag, as I hinted earlier. And it is to do with income. You see, dividend payments are a bit on the thin side these days so the dividend yield on the FTSE All-Share index is only 2.49%. Put another way, it means you get a gross income of £24,900 from a million pounds invested across the market. Not bad, but it is only equivalent to the average wage, and you'll have to pay tax on it, so it won't exactly be the life of Riley. Even so, you will be comfortable, and be able to maintain and increase the real value of the windfall over time. Your fund is inflation-proofed and the value of the dividends will rise every year. And that's it, no more work involved at all. That's not to say you can't manage the fund more actively to get better returns if you want. But you don't have to.

Finally, there is no point in dying a wealthy man or woman and giving 40% of your estate to the taxman. IHT planning is beyond the scope of this article but one idea is to gradually sell units in the tracker each year, preferably not exceeding your Capital Gains Tax allowance of £7,200, to augment your income for those little extras. Even doing this you will probably still have enough money left to give somebody else a nice windfall when your time is up. And they can learn from your example and start the process all over again.

More: Index Trackers | Set up a portfolio | Guide to Wills & Probate