Coming into a lump sum of money is great but if you’re not looking to spend it straightaway, you’ll be faced with figuring out where to invest a lump sum of money. Depending on your individual circumstances, along with your future goals and appetite to financial risk, where you invest your windfall can have significant ramifications. Even giving it all away – unless it’s to a charity – can attract unexpected tax bills that can catch out the unwary.
Receiving a lump sum of money
If you’re at the age of retirement, the most likely source of a lump sum will be a retirement pot maturing. If your retirement savings are now ready to be converted into a pension from which you draw an income, you can get access to 25% of the pension pot tax-free. If you’ve built up a pot of £100,000 then £25,000 represents quite a windfall.
You may also receive a lump sum as part of an inheritance from a family member who has died. If you are a beneficiary of a will, remember that the deceased’s estate is subject to inheritance tax – currently 40% on anything above £325,000 on the total value of the estate.
Want to know more about inheritance tax? Read our free guide to inheritance tax planning – what is inheritance tax so you can maximise any inheritance lump sum.
Other lump sums may arise from downsizing your main home to release equity or a redundancy payout. For the latter, any amount up to £30,000 is tax-free. You could, of course, have won the lottery. In that case even better, as the entire amount of a lottery win is tax free.
Where to invest a lump sum of money – before you start
This first thing when you get over the shock of a sudden windfall is to think about where to invest a lump sum of money. This will depend on your current situation and your future plans. Are you retired or thinking about retirement? Are you thinking of moving house or downsizing, travelling abroad or just want less financial stress?
Take time to think about your goals and where you liked to be financially in 10, 20 and 30 years. Having a goal in mind, will help you choose where to invest a lump sum more easily. For example, most people aged 50 and above who receive a windfall will consider investing the lump sum to supplement their income in retirement.
You might want to invest the lump sum into a private pension – attracting considerable tax relief of 20% for basic rate tax payers and up to 40% for higher rate tax payers. Read our free guide to pension drawdown – how to set up pension income drawdown to get ideas on how to top up your pension.
Before deciding where to invest a lump sum of money, clear as much debt as possible before you even consider investing it. The priority should be loans that have a high interest rate, such as payday loans, or store cards. Paying off credit cards is a must, as well as any hire purchase agreements with interest repayments. If you have a mortgage, then look at how you can pay off more capital. Some mortgages attract an early repayment penalty, so check with your mortgage provider the cost of overpaying some or all of your outstanding mortgage balance.
Options for where to invest a lump sum of money
After paying off debts and putting some cash aside for emergencies – aim to have around £10,000 in accessible cash as a reserve – you can look at options for where to invest a lump sum of money. In all cases when investing a sizeable chunk of change you should seek advice from an independent financial advisor. They can take a look at all your financial needs and recommend products across the market that are best suited to your needs.
Stuck trying to find a good independent financial advisor (IFA)? Read our free guide to pensions advisors – how to find the best IFA for advice on where to find the right IFA for your circumstances.
Savings account or bond – Many people prefer to keep around 5 per cent to 10 per cent of a lump sum in an instant access or limited withdrawal savings account. This allows you to access your money as needed – either as an income, as spending money or as a rainy-day fund. There’s also less risk, as your money isn’t invested in the stock market which means if the stock market falls your lump sum is safe. Crucially, this means you’ll always get back at least the value of the money you put in. But that risk protection comes with a price: interest rates are very low. Agreeing to lock your money up for, say, five years in a fixed-rate bonds can see you earning a rate as high as 3%, nudging your savings above the rate of inflation.
ISA – You’ll pay tax on most high interest savings accounts, but ISAs keep your money in a tax-free wrapper. Whatever you earn in interests is tax free, and you can invest in stocks and shares or keep things simple with a cash savings ISA. All income from interest is also tax free, and if you’re married or with a long-term partner you trust, you can split the lump sum across two ISAs to take advantage of both sets of individual tax allowance. ISAs have been increasing in how generous they are with tax allowances, and currently you can invest £20,000 each year into an ISA.
Premium Bonds – Still a favourite for savers, and everyone likes a flutter on ERNIE. There is no interest paid on a Premium Bond, and the minimum investment is £100. However, each month all bonds are entered into a prize drawer with prizes ranging from £25 to a whopping £1m. The more bonds you have, the greater your chance of winning. Any winnings are tax free, but the chances are you’ll end up with less income from your lump sum compared to sticking it into a high interest account.
Pension fund – There are some significant tax advantages to putting a lump sum into a pension fund, but be careful as too big an investment could see you paying tax on the amount you put in. Currently you can stick £40,000 or the same amount equal to 100% of your earnings in the tax year, whichever is lower and benefit from tax relief. If you earn more than £40,000, that’s the maximum you can put in and claim tax relief. If you earn less, then you can only put that much in before hitting the tax relief ceiling. It’s a bit more complicated, because for every £80 you put in as a basic rate tax payer the government adds a £20 bonus, meaning you can add around £32,000 and the government will top up the rest to £40,000. Remember that 25% of your pension is tax-free as lump sum when you retire, so if you can afford to lock up your lump sum into a pension it’s a great way to use it to get more money.
Property – Investing in bricks and mortar could pay handsomely according to research by money.co.uk. It reckons property values could double over the next 20-25 years, so keeping your money in property could be a sound investment. However, the buy-to-let market is more challenging, with recent government tax legislation meaning returns are lower margin, making earning an income from buy-to-let more difficult. The good news with investing in property is the larger the deposit – which should be sizeable if you have a decent lump sum – the better the mortgage rates available, meaning you can invest in a property with a lower interest mortgage and watch it grow in value over the years.
Stocks and shares – A more risker strategy in terms of where to invest a lump sum of money is in stocks and shares. The risk is that the value of your investment can fall as well as rise, which means you could actually end up with less money back than you originally invested. But, stock markets have historically risen and while the past is no guide to the future, if you can keep your investment over a longer period of time – at least five years, and ideally 10 or more years – the peaks and troughs smooth out and you could see a decent overall return. Just be prepared for the occasional rollercoaster ride in the meantime. You can either invest directly – often cheaper than paying an advisor, but you might miss out on stock market experience – or buy into a portfolio of shares run by an investment company. That gives greater buying power and access to experts, but you’ll pay high advisor fees.
Spreading the risk when investing a lump sum of money
While you should get independent advice, it’s wise to think about spreading where you invest your lump sum across a range of financial products. Putting a portion of it into low-risk investments will protect a part of your lump sum. You could invest a smaller portion into higher risk investments such as stocks and shares. The aim is to spread the risk, so if something performs poorly all your capital is not tied up in it.
It’s also worth ensuring your lump sum isn’t sat with one financial institution, especially if you have over £85,000. While the collapse of a high street bank is unlikely, it has happened. The Financial Services Compensation Scheme (FSCS) will protect any sum up to £85,000 held in a single institution should, for example, your bank fail. If you have more, split it into smaller chunks and keep each portion below £85,000 with different banks. This will ensure the entire amount is protected should the banks fail.
Make a gift as an alternative to investing a lump sum of money
Another option is to give some money away as gifts, as this can help reduce any future inheritance tax bill your family will have to pay. You can give away up to £3,000 in any financial year with no tax implications. And you can gift any amount so long as you live for seven years afterwards, and any gifts you make will be free of inheritance tax after that time. You can also give £250 to anyone as a trivial gift and it is ignored for tax purposes – which is a great way to spread the joy after getting a windfall.