What to do if you inherit a lump sum
Very few of us haven’t dreamt of winning the Lotto or waking up to find that we have inherited a large lump sum from some distant and unknown relative. We think about the things we could do with it, the new car, the dream holiday, the brand spanking new kitchen, the Croke Park premium seat, or the shopping trip to Paris.
But not too many of us think beyond those whimsical wish lists when it comes to what we might do with newfound wealth. Having fun is important of course, but we have to think about the longer term as well.
With debt you should part
The first thing to think about should good fortune land in your lap is your debts, particularly the high interest ones like credit cards. For example, a €5,000 credit card debt could run up an interest bill of €1,233 and take more than two years to pay off if you make the minimum payment of €250 and keep paying that amount each month. All that money, along with the need to make the monthly payments, could be saved at a stroke by paying off the debt.*
The next thing to look at is your car or personal loans, if you have any. An average rate at the moment would see you repaying almost €12,220 over five years for a car loan of €10,000. That may sound pretty good but wouldn’t the €2,220 be better in your pocket than the bank’s?**
Then there’s your mortgage. Even at today’s very low interest rates you’d be surprised at just how much you could save by paying off some or all of it. Paying off a mortgage with €80,000 outstanding and ten years to go could save more than €14,300. Again, better off in your pocket than the bank’s.***
Needs come first, wants later
Once you’ve looked at what you can gain from paying off your debts the next thing to address is where to put the rest of it. The best approach here is to look after short, medium and long-term needs and divide your lump sum into three pots to look after each.
Short-term needs are usually pretty straightforward to work out. You will usually have a good idea of what extra money you might need over the coming months. In addition to this though, you should also consider putting some money aside to cover any of those unwelcome unexpected costs. Putting that money in a standard deposit account that you can withdraw at a moment’s notice will ensure that you are not caught short should a rainy day come along. But do shop around for the best rates and don’t be put off if you have to give notice of a week or two to get your money out.
Medium to long-term needs include children’s or even grandchildren’s education bills and other fairly significant costs which you know you need to plan for. These costs can include family weddings, car replacements, home improvements, and possibly even giving your children a helping hand with buying their first home.
Calculating these costs is not easy but it is not necessary to be very precise. The point of the exercise is to ensure that you have a reasonable sum put aside to meet fairly significant costs as they might arise over time. That could mean someone with two children working out the cost or a college education for both of them now and putting that amount into a long-term savings or investment plan which offers a potential rate of return which will at least match the rate of inflation.
The golden horizon
And then there is the longer term. The main item here should be your pension plan. Do you have one? How much is it worth if you do? What might it pay out on retirement? What do you need to put into it to get a decent retirement income from it?
There are all sorts of managed funds which invest in different markets and assets which you can invest in for your medium to longer term goals. There are funds that are tailored to the level of risk you are willing to take so you can invest in a fund with a level of risk that you are comfortable with.
Finally, never, ever make any decisions regarding a lump sum without first taking professional advice. Even what appears to be a large lump can become very small very quickly if the wrong decisions are made early on, or if you go on a spending spree before putting some of the money out of your reach.
1. Take professional advice
2. Consider paying off debts
3. Put something aside for the rainy day
4. Look at medium term investments for big ticket items like college fees and car replacements
5. Take care of the long term with pension investments
6. Don’t forget the dream holiday or car
*The Annual Percentage Rate (APR) calculated is based on the average of APR rates from five of the main banks in Ireland and is correct as at 19/10/2017.
**The APR is based on the average car loan APR from five of the main banks in Ireland and is correct as at 19/10/2017.
***Based on the average mortgage rates from five of the main banks in Ireland based on fixed, first time buyer mortgage with a Loan-to-Value (LTV) of 80% being paid over 35 years. Information correct as at 19/10/2017.