What to Do With a Windfall: The Important Things to Understand

They say money can't buy happiness but studies show otherwise. At least, people with more money tend to be happier.

It's not the money that buys happiness, it's what the money can do for you. Less stress, fewer debts, and special purchases can all help you live a happier life. But what makes the biggest difference in your outlook?

Let's look at what to do with a windfall and how to make the best choices.

When you come into money unexpectedly, it's easy to make snap decisions about what to do with it. This is especially true if you've got a debt to pay off or urgent expenses.

Don't let yourself get carried away. Before you do anything with your windfall money, consider all your options. If possible, talk to a financial planner to get their professional advice. They'll be able to give you guidance about the tax implications and the pros and cons of different alternatives.

The tax implications of a financial windfall will vary depending on where the windfall comes from. Some windfalls, like lottery winnings and gifts, may not be taxable while others, like an unexpected bonus from your job, could create a sizeable bill at tax time.

The last thing you want to do is invest or spend your money and not be able to access it to pay the tax bill.

It's not very difficult to build an emergency fund for you. In case you were to lose your job or any significant expenses came up suddenly, this fund can save you financially. Set part of your cash windfall aside, putting it into a savings account or somewhere else that you can access it on short notice.

Investing your money in something that will appreciate or pay you dividends on an ongoing basis is a good way to use some or all of your windfall. If the amount is large enough, you can create a decent income stream through dividends or interest payments and never need to dip into the principal.

Paying off debt is one of the most effective ways to use a windfall, especially credit cards and other high-interest consumer debt. Credit cards often have interest rates ranging anywhere from 10 to 20 percent or more.

Paying off that debt is like investing your money in something that gives you a 10 to 20 percent return. There aren't many investments that can offer that kind of ROI and the ones that do are usually pretty risky.

Paying down your mortgage is another way to pay off debt but it's not as straightforward as paying off consumer debt. Mortgage rates are much lower than consumer debt interest rates and if you have a good rate on your mortgage, it might make more sense to invest the money at a higher return.

You may also have to pay fees to pay down your mortgage. Many mortgages have an annual maximum you can pay over and above your normal payments. If you want to pay off more than that, the extra fees you pay could end up costing you more than you save in interest.

Whatever you decide to do with most of your windfall, it's a good idea to set some aside to use for something fun. It might be a trip you've always wanted to take, a new car you've been eyeing, or something else you've always wanted.

Treating yourself to something you wouldn't have been able to afford before the windfall is a nice reward for using most of it for something responsible.