How To Use Windfalls Wisely: Paying Down Debt Versus Saving For The Future

Receiving a financial windfall, whether from a tax refund, a bonus at work, or even an unexpected inheritance, can feel like a major relief. However, deciding how to best use that extra money can be tricky. Should you focus on paying down debt or stash it away for future financial goals? The right answer depends on your personal financial situation.

Here’s how you may want to prioritize that windfall wisely:

1. Assess Your Current Financial Situation

Before making any decisions, take stock of where you stand. This includes looking at:

• Your current debts (credit cards, student loans, car loans, etc.)
• Interest rates on those debts
• Your savings (both emergency fund and longer-term savings like retirement)
• Any upcoming financial goals (buying a home, paying for education, etc.)

A clear picture of your overall financial health will help you decide whether tackling debt or saving should be your priority.

2. The Case for Paying Down Debt

Debt, especially high-interest debt like credit card balances, can weigh down your finances. Carrying debt costs you money in the form of interest payments, making it harder to achieve your financial goals. If you’re facing high-interest debt, paying it off should often be your first move with any windfall.

• Focus on high-interest debt: The higher the interest rate, the more you’re paying over time. For example, credit card debt can easily come with interest rates of 18% or more, meaning your debt grows quickly.
• Financial freedom: Being debt-free not only reduces financial stress, but it frees up your budget for saving, investing, and other financial goals.

When to prioritize paying down debt:

• You have high-interest debt (above 7-8% interest).
• You want to improve your credit score.
• The debt is causing significant stress or hampering your cash flow.

3. The Case for Saving for the Future

On the other hand, putting some of your windfall toward savings can also be a smart choice, especially if you don’t have a financial safety net or if you have long-term goals in mind.

• Emergency fund: Financial experts recommend having 3-6 months’ worth of living expenses saved in an easily accessible emergency fund. If your savings are lacking, it may be wise to put part of your windfall toward building that cushion.
• Retirement savings: The earlier you start saving for retirement, the more your money can grow. Windfalls can be an excellent opportunity to boost retirement accounts like a 401(k) or IRA, especially if you’re not currently contributing the maximum amount.

When to prioritize saving:

• You have little to no emergency fund.
• You’re behind on retirement savings.
• You’re preparing for a major purchase or life event (house, car, education).

4. Finding a Balance

If you have both debt and savings needs, a balanced approach may be the best solution. Consider splitting your windfall between the two. For example, you might use 50% of your windfall to pay down high-interest debt and the other 50% to bulk up your savings.

• Debt-savings ratio: For those with significant debt and minimal savings, it might be wise to devote 70% to debt and 30% to savings. If you have an adequate emergency fund but want to accelerate debt payoff, a 60-40 or 50-50 split could work well.

5. Investing Your Windfall

Once you’ve tackled high-interest debt and built up your savings, you may want to explore investing part of your windfall. This could be in the form of contributing more to retirement accounts, investing in the stock market, or even pursuing education or certifications that can boost your earning potential.

6. Consult with a Credit Counselor

If you’re still unsure how to best allocate your windfall, a non-profit credit counselor can help. They can assess your unique financial situation and offer personalized advice, ensuring you make the most of this opportunity.

Conclusion –

A financial windfall offers the chance to improve your financial health, whether by paying off debt, building savings, or both. By carefully weighing your options and considering both your present needs and future goals, you can use your windfall to set yourself up for long-term financial success.

Disclaimer: The information provided is for informational purposes only. The materials are general in nature, are not offered as advice or guarantee, and should not be relied upon without guidance from an attorney or a financial advisor. Reading the information does not constitute a legal contract, consulting, or any other relationship with Advantage Credit Counseling Service.