Britannica Money (2024)

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Think about tomorrow's needs, not today's wants.

Key Points

Some financial windfalls, such as bonuses, gambling winnings, and insurance settlements, are taxable.
Consider paying off debt and boosting your emergency fund before spending your newfound cash.
Once you have the basics covered, consider where you would get the most benefit from spending the extra money.

Your windfall might take the form of a tax refund, a gift or inheritance, a bonus, or even winnings from gambling. In any case, it pays to use the money wisely.

Tax refunds

As you earn income throughout the year, your employer takes money out of your paycheck to pay income tax and other taxes. If you’re an independent contractor or self-employed, you’ll likely make quarterly tax payments. But these tax deductions and payments are just estimates.

At the end of the year, you fill out a Form 1040 to calculate the taxes you truly owe. If you’ve paid more than that amount, you get a tax refund. So your refund is essentially money you set aside all last year that is now paid back to you in a lump sum. If your tax refund is from state taxes and you itemized, that refund is taxable the following year. Federal tax refunds, however, are always tax free.

Bonuses

Many employers give bonuses in conjunction with annual reviews, the holidays (or year-end), as a recruiting tool, or for plenty of other reasons. But any bonus you receive—even a gift card—is taxable. Your employer adds the bonus to your earnings, and you usually pay a 22% flat tax, rather than the rate calculated by your Form W-4.

Suppose your employer offers you a $1,000 bonus. The company might take all of the taxes owed out of that amount (leaving you with about $700 or less, depending on state taxes). Or they can “gross it up,” which means giving you a bonus higher than $1,000 in your earnings, taking taxes out, and leaving you with $1,000 in cash. Most often, employers gross up a gift card or small cash award.

Monetary gifts and inheritance

In general, money you receive as a gift or as an inheritance is not taxable to you at the federal level (although a handful of states do require state taxes on inherited money). But in most instances, any taxes assessed are paid by the giver or the estate. If you’re the beneficiary of a life insurance policy, money you receive after the death of the insured person is not taxable.

Savings bonds: The gift that doesn’t give till maturity

If you received paper bonds as a gift or as part of your tax refund, you’ll get the most money by waiting to cash them after they mature. The Treasury Direct website features a bond calculator that tells you how much your bonds are worth. When they have matured, you can redeem them at your bank and have the proceeds deposited into your savings account. You’ll pay taxes on the interest you earned over the life of the bond, although certain bonds are not subject to state and local tax.

Lottery and other gambling winnings

If you occasionally gamble for fun—not as your main source of income (in which case you would pay income taxes as you would with any job)—there are Internal Revenue Service (IRS) rules that govern gambling income and losses.

Gambling winnings, including cash as well as trips or other prizes, could come from:

Gambling winnings are fully taxable and you must report the income on your tax return, according to the IRS. Depending on the type and amount of your winnings, you may receive a Form W-2G that shows your gambling proceeds. If you won more than $5,000 (or other certain situations) you might have estimated taxes withheld from your winnings before your check is cut. If estimated taxes are not withheld, be sure to set aside a portion to cover taxes.

Insurance settlements

You pay for car and home insurance so that after an accident or disaster you can be “made whole”—that is, returned to about the same financial state as before the incident. When you make a claim with your insurance company, an estimate of the damages is made, a check is cut, and sometimes it’s sent directly to you.

The entire amount is expected to be spent to repair that dented bumper or flooded basem*nt. But if you spend less than the amount issued, the leftover money could be considered taxable. Also, insurance proceeds that pay for lost wages or pain and suffering are taxable.

Spending and saving the unexpected dough

Consider how you want to use your tax refund, bonus, or other windfall. Depending on your financial situation and your goals, you might consider the following ideas:

Pay off debt. If you have credit card debt, or other debt at a high interest rate, it’s a good idea to pay it down or off before you use the money for other purposes. You’ll save on future interest charges and improve your personal balance sheet.
Add to your emergency fund. If you don’t already have one, use unexpected money to start or add to an emergency fund that you can use for future unexpected expenses.
Add to your retirement savings. If you have a 401(k) plan and your employer matches bonus contributions, you may choose to save part of your bonus for retirement. If you don’t have a 401(k) but can contribute to an individual retirement account (IRA), consider putting some of your windfall there. With compounding interest, investments you make now will grow and become worth more by the time you retire.
Buy a new home or car. By using unexpected money toward purchasing a new home or car, you’ll reduce the amount you need to borrow and will later save on interest. Not ready to take the plunge? Save toward a down payment for the future.
Repair or improve your home or car. Spending money on your assets will make them more valuable and last longer. A new roof, for example, could help you avoid expensive water damage, while new tires will make your car more stable, helping you to avoid costly crashes.
Take classes, attend a conference, or get a certificate. Gaining new knowledge and skills will help your career—and enrich your life.
Contribute to your favorite charity. Consider donating part of your windfall to help others in need. You may be able to take a tax deduction if you itemize.
Spend money on a specific splurge. If your other financial basics are covered, consider treating yourself or putting your money toward a splurge such as a trip.

The bottom line

A cash windfall is just that—unexpected money that comes your way. Don’t make the mistake of assuming you’ll get another one next week or next year, especially if it came from games of chance, like playing the lottery or gambling. Keep budgeting based on money you know is coming in the door.

If your windfall resulted from a tax refund, it would be wise to do some tax planning for next year. By letting the government keep your money for a year before it’s refunded, you’re essentially providing Uncle Sam with an interest-free loan. Update your Form W-4 to withhold the correct amount from your paycheck each pay period to avoid getting a large refund next year. Plus, withholding less tax from each paycheck means you’ll have more to spend on day-to-day expenses.

References

Topic No. 419, Gambling Income and Losses | irs.gov
Paper Savings Bond Calculator | treasurydirect.gov