Special Handling for Sudden Wealth

How to parcel out and protect an inheritance or pension payout in these uncertain times.

By Kimberly Lankford, Contributing Editor

From Kiplinger's Personal Finance magazine, January 2009

Getting a big year-end bonus? You wish. Becoming a stock-option millionaire? So last century.

But even in hard times, you could come into a chunk of cash that's independent of the economy and the stock market -- an inheritance, say, or a pension distribution. Or even that most dubious of windfalls: severance pay.

Whatever the source of your extra money, you have a lot more at stake these days in figuring out what to do with it. You want to improve your financial situation -- and preserve your assets -- but which goal should you tackle first? How should you invest in this volatile stock market? Should you even invest at all? We offer both guidance and reassurance.

Set Your Priorities

Jason Hartman works for an employer that's still giving out bonuses. He is a technician who disposes of explosive ordnance for the U.S. Army -- in other words, he's on the bomb squad -- and he just received a $29,000 bonus for reenlisting. Hartman also has extra cash from the combat pay and tax-free income he earned while he was deployed to Iraq for four months in 2008.

Sergeant First Class Hartman initially contacted Kiplinger's while he was still in Iraq, looking for "a good place for the money until the economy straightens out." He and his wife, Tara, are both 29, and they have two sons, 4-year-old Logan and 2-year-old Reese. They'd like to use some of the money to pay down credit-card debt, boost their retirement kitty and save for a down payment on a house in Fayetteville, N.C.

With so many goals, the Hartmans' first priority should be to do nothing. Brooke Salvini, a CPA and financial adviser in San Luis Obispo, Cal., recommends that you put an influx of cash into a savings account with an online bank, such as HSBC or ING Direct, so that you can earn interest while plotting your next move. And having the money on hand will be convenient if you owe more in taxes than has been withheld -- a common occurrence.

Hartman is following through on the Army's equivalent of Salvini's advice by investing about one-third of his bonus in the military's savings-deposit program, which lets deployed service personnel contribute up to $10,000 to an account that earns 10% per year. Interest stops accruing 90 days after you leave the combat zone, and interest is taxable when the money is withdrawn.

If you don't need your extra cash for everyday expenses -- as you might if you receive a pension payout or severance pay -- you could first use some of the money to pay down high-interest debt. The Hartmans are paying 7.9% interest on a $9,000 credit-card balance. Patrick Beagle, a former Marine helicopter pilot and now a financial planner who specializes in counseling military families, recommends that they pay off the entire balance because the savings on interest payments will make it easier to reach their other goals.

Financial advisers used to recommend that families maintain an emergency fund large enough to cover three to six months' worth of living expenses. But given the current state of the economy, many have bumped up that amount. Salvini suggests stashing enough for six to 12 months' worth of expenses, and double that if you or your spouse works in a field that's vulnerable to layoffs. And if you own rental property, you may need to set aside even more if you anticipate you'll have trouble collecting rent from cash-strapped tenants.

In addition to your emergency fund, stow some money in a safe place, such as a one-year certificate of deposit, for expenses you anticipate in the near future. These might include home repairs, a renovation or a big trip. "Investing in the stock market is just for money that you won't need for at least three to five years," says Salvini. That's advice that investors are finally starting to appreciate.

After the money in the Hartmans' military savings program stops earning interest, Beagle recommends that they put some of it toward a down payment on a house -- assuming they'll be able to stay put for at least five years (Hartman figures they'll be in Fayetteville for at least ten years). Beagle also recommends that the Hartmans hold their housing costs to no more than 30% of their take-home pay so that they won't struggle with monthly expenses after their extra cash is gone.

While you're making all of these serious financial decisions, here's something that might not have occurred to you (or if it did, might have made you feel guilty): It's okay to have fun with some of your money. That's especially true if you've just been through a stressful experience -- such as being on the Army bomb squad in Iraq. Beagle says you could spend as much as 5% of any windfall -- $1,400 in the Hartmans' case -- on a weekend retreat, a family trip to a theme park or some other splurge.

That goes for money you inherit, too. "The person from whom you inherited the money would probably like to see you do something other than 'the right thing' with at least a small part of it, or even more," says Tim Maurer, a certified financial planner in Hunt Valley, Md.

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