Updated 22 March 2022
However you come into a lump sum of money, you’ll need to decide how best to use it. Whether you want to use it to buy a house, put it towards your children’s education, or even simply save it for the future, there are a number of options immediately available to you. Thankfully, we’re on hand to break things down, so here is our guide on how to spend a lump sum wisely.
You can come across a financial windfall when one or more of your sources of income, or another source altogether, pays a large single sum of money to you. This could come from winning the lottery, inheriting, a redundancy payment or drawing on your pension, for example.
Lump sums differ from other ways of saving. While some savings will offer gradual returns, lump sums are larger amounts that can collectively earn a lot more interest. This means that with the right saving strategy, not only will you be able to put your lump sum towards your priorities, but you will also benefit from the additional interest.
Everyone’s financial situation is different, meaning that deciding how to use your lump sum ultimately rests with you. The decision will depend on the size of your windfall, personal circumstances, and how much risk you want to take on. If you have around £10,000, are looking to save towards your retirement and prefer to save your money with little risk attached, you may prefer to keep your money in a savings account. If you have a larger amount and don’t mind taking on a little more risk, you may achieve better returns investing your money directly.
One of the biggest priorities many people have is paying off debts of various kinds. Some debts, such as credit card debt, can quickly begin to multiply when not repaid on time, so oftentimes, the first priority is to resolve any outstanding payments that you may have. If you’re looking to take control of things like credit card debt, lump sums can go a long way towards improving your financial situation and relieving a lot of stress. If you do need help taking control of debt, it is always a good idea to consult a financial adviser.
Investing a lump sum is one of the more popular ways for people who are more comfortable with higher levels of risk to invest larger amounts of money. Higher risk means your chances of greater profits are also higher, so risk isn’t always a bad thing. It’s important to only invest amounts of money you are comfortable with, and into investments that you are confident of. To understand more about investing money, you should speak to an adviser.
As interest rates are currently low, many people are deciding that waiting for interest to build over a few years – investing into stocks, shares and potentially bonds – is a better way to build savings. Each different investment you make will have a different level of risk and your returns will vary as a result. But as a general rule, wait at least five years before taking out your lump sum as this allows savings to build, interest to accrue and allows your investment time to recover any losses it may have incurred.
Regardless of what you choose to invest in, there are some effective ways to reduce your risk. As there are different kinds of risk, it’s important to understand what potential downsides there are to each investment. But if you come into a large financial windfall, you may want to split this sum into two halves, with one part invested into stocks and shares and the other into a safer savings account.
However you choose to invest your lump sum, it may also be a good idea to build an emergency savings pot. Typically, an emergency savings pot should cover about three months' salary and be quickly accessible so that you can use it whenever you need. These kinds of savings will cover you in case of unforeseen circumstances, such as redundancy or illness. Always check with your employer about its workplace illness policy and the eligibility criteria, but having emergency savings to support you in times of need will give you a little more peace of mind.
If your lump sum is a smaller amount or you would prefer to save your money towards certain priorities, a simple savings account might be the better option for you.
Cash savings are always popular with people who want to put away a lump sum and earn interest over a long period of time. This can be a very good way to save for things, without taking on bigger levels of risk. Savings accounts are much safer, but how much interest you earn will come down to your bank’s interest rate. As interest rates are typically quite low at the moment, it could take a while to earn a good amount of interest.
Individual Savings Accounts (ISAs) are a particularly good way to save towards a house purchase or retirement, or – with some particular ISAs – your children’s future. There are a number of different ISAs available for different savings purposes, and each can involve different kinds of financial products and savings amounts.
You could put your lump sum into an individual cash ISA, where you can earn tax-free interest on up to £20,000. If you’re looking to save towards your first house, you could also consider a lifetime ISA. These ISAs allow you to put up to £4,000 a year into a savings account, with a limit of £20,000. Lifetime ISAs were introduced with the explicit intention of helping 18-40-year-olds save towards their first homes. So, if buying a house is your goal, this type of ISA is a good option. There are also junior ISAs that can help with saving money towards your children’s future. These ISAs let you save up to £9,000 a year and can be only withdrawn once the children are over 18. If you're looking at making potentially larger gains (but at an increased risk), you could also consider investing in a stocks & shares ISA.
Whether you’re looking to invest or save your lump sum, having a financial windfall at your disposal can help pay back debts, buy your first house or save for your children’s future. Investing, saving and building for your future is important, so it’s vital that as you’re making decisions about your financial future, you have the right advice. For your expert financial adviser, trust Unbiased.