From lottery wins to inheritance: how to protect a windfall

Pay off debt, invest your money, guard against Inheritance Tax: we look at the essential steps you should take if you come into money.

Coming into a lot of money, whether through inheritance, a lucky lottery win or any other means, can be a little daunting. Sure, it's nice to suddenly have access to funds that you didn't have before, but it can get a little overwhelming, especially if you start worrying about how to protect your new-found wealth.

Fortunately, there are steps that you can take that will ensure your finances are protected. 

Take some time to think

Due of the nature of the payment, many people view a windfall, bonus or unexpected inheritance differently from money they have worked hard to earn. As a result, they can get carried away with the luxury lifestyle that they can now afford, and end up blowing the lot.

Instead, it's a good idea to stash your money away into an easy access savings account, at least for a little while. The interest available won't be the highest available, but it will give you time to put together a more long-term financial plan. Currently you can get a rate of 1.65% with RCI Bank. Head over to the loveMONEY savings centre to compare the best deals in the market today.

Bear in mind that the current Financial Services Compensation Scheme (FSCS) protection limit is currently £85,000 per individual per banking institution (and is falling to £75,000 from 1 January 2016) so you may need to consider more than one institution to maximise this protection. 

Keep it quiet

If friends and family catch wind of your good fortune, you may find that you're getting more visitors than normal and everyone's being extremely nice. But being overly generous to your nearest and dearest can result in your windfall quickly disappearing.

While it might be difficult to hide your new lifestyle from those you know, it may be worth creating a ‘cover story’. And never share precise details of the amounts of money involved, suggests Martin Bamford, chartered financial manager at Informed Choice.

Don’t forget the taxman

Tax implications vary depending on the type of windfall you’ve received.

When it comes to an inheritance, for instance, tax is currently levied at a rate of 40% on the value of an estate above the tax-free threshold, which is £325,000 per person. Married couples and civil partners are entitled to double the allowance, passing on assets to their children or other relations worth up to £650,000 before a tax charge is triggered. Read How to cut your Inheritance Tax bill.

When it comes to the lottery, this money is treated as a gambling win, and as such payments are tax-free. However once the payment has been made, any interest or income generated from the capital will be subject to Income Tax at your highest marginal rate.

What’s more, if you give away some of your winnings and die within seven years they might be subject to Inheritance Tax. 

If you’ve come into your money by selling an asset that has increased in value – shares, for example – you may have to pay Capital Gains Tax if it exceeds the annual tax-free allowance of £11,100 for 2015-2016. For more read Ways to avoid Capital Gains Tax.

Clear your debt

The interest you pay on outstanding borrowing can wipe out any gains from savings, so it is a good idea to clear your debts first.

If your lump sum is not large enough to wipe out all your debts, focus on loans secured against your home or credit cards with high interest rates.

Think about saving or investing

Always make the most of tax-efficient savings options such as your ISA allowance first. You can invest up to £15,240 in an ISA between now and 5 April 2016. 

If you’re willing to take more risks with your money, you may decide to invest. Investments can potentially yield greater returns than savings, but you could lose some or all of your money. If you’re thinking of investing your windfall, it's a good idea to seek financial advice. You can find an independent financial adviser in your local area, visit Unbiased.co.uk.

Open a Stocks & Shares ISA today

Look to the future

It can be tempting to spend an unexpected windfall on something short-term, like a new car or a holiday. But if you don’t have much in the way of savings for your retirement, you should think about ploughing some of that cash into your pension pot. You can do this either by topping up an existing pension, or starting to save into one to help make sure you’re financially secure when you stop working.

When it comes to pensions, you can invest up to £40,000 a year wuthout worrying about tax, although bear in mind that there is a £1.25 million cap on the maximum value of a pension pot before you are taxed, which drops to £1 million from April 2016.

Open a SIPP today

Sort out your estate plan

Coming into a large lump sum should certainly act as a prompt to review your current estate plan or, if you do not already have one, to put one in place.

While you may be happy for your children to inherit a few thousand pounds when they reached 18, you may feel very differently about them inheriting a lot more.

One option is to stagger payments, perhaps up to the age of 25 or even 30.

“You may have already paid a substantial amount of Inheritance Tax when you received the money and if your estate is now over the relevant threshold, the money could be taxed again when it passes to your children,” points out James Wallace, senior associate at law firm Aaron and Partners.

“It can be a good idea to skip a generation and pass some of the money to your children or grandchildren straight away, thereby mitigating the effect of Inheritance Tax” he adds. 

Keep the taxman away from your money:

Stealth taxes that will hit you in 2016

Make the most of your new £5k tax break

How to beat the taxman