You may have received a lump sum from an inheritance, or perhaps from shares divested on the sale of a business. You may be one of the few to enjoy a lottery win! Whatever the reason for the windfall, we believe it’s essential to explore your options when it comes to making the most of your money.

When deciding what to do with a lump sum, there are a number of things to consider:

The nature of the windfall might also influence your priorities. For instance:

Perhaps the first consideration is to identify how you might get the best return on your money for the amount of risk you are prepared to take.

Risk is a tricky subject, but one that is critical to discuss. Some investors enjoy a choppier ride on the stock market for the possibility of larger gains, while others will feel deeply uncomfortable with the thought of the potential losses. And there’s the issue of affordability. Even if you are willing to take a bigger risk, how much can you afford to lose without an adverse impact on your current lifestyle, or damage to your long-term financial objectives?

If you have a lot of money to invest, you’ll probably look at an investment portfolio that divides your money between several different types of investment. You may want to keep some cash in a savings account so it’s easily accessible, put a portion into an investment fund that should provide a higher return, albeit with risk attached, and use the rest to boost your pension fund or perhaps invest in property.

At this point, we should also mention HM Revenue & Customs (HMRC). With investing comes tax implications, but there are ways to minimise the amount you pay. Good financial planning will always incorporate annual personal tax allowances as well as the range of tax-efficient investments available, including Individual Savings Accounts (ISAs) and pensions.

All of these considerations highlight the importance of independent, expert advice courtesy of one of our financial planners. They will get to know you and your current circumstances, review your goals and advise on the best ways to invest your money. If you choose, they can also continue to manage and monitor your investments to ensure they perform in line with expectations and your risk profile. They will also help to adapt your financial plan to accommodate any changes to your current lifestyle and future goals.

Cash savings

It’s important to have cash that you can access quickly for emergencies and any unpredictable events. You should aim to keep at least three to six months’ worth of essential expenses in a savings account, separate from the money you dip into regularly. This will help avoid the stress of unexpected bills or repairs and provide a safety net if you’re not able to work. While it’s inevitable you’ll dip into your reserves at some point, it is worth topping up as and when you can.

Repay debt

It’s also sensible to pay off any debts, especially those with high-interest rates such as loans and credit cards. Clearing debt not only reduces your outgoings but also your vulnerability if things go wrong. If you have a mortgage, it’s worth reviewing to see whether you can overpay to reduce the term or remortgage to a better deal.

Top up your pension

Topping up your pension with a lump sum is a highly tax-efficient investment:

• For every £80 you contribute, a further £20 is credited to your pension in the form of tax relief (subject to certain limits)
• Higher and additional rate taxpayers can claim additional relief via Self-Assessment
• You don’t need to pay tax on the growth yield from your pension assets
• You can withdraw up to 25% of your pension tax-free after you reach the minimum pension age (currently 55, but due to rise to 57 in from 2028)
• Once you retire, your remaining pension will be taxed at your marginal income tax rate but can be drawn flexibly as you wish, or you can use it to purchase a secure income
• Pensions are not usually subject to Inheritance Tax and can be passed on to your beneficiaries in full if you die before age 75. If you live beyond 75, beneficiaries can still receive your pension fund but will pay tax at their marginal rate
• Redundancy payments are generally taxable, over £30,000, but placing the excess in a pension fund can reduce your tax bill for the year
• There are caveats to be aware of when investing money in your pension, and the rules are complex and change frequently. For example, there are limitations on personal contributions per year that qualify for tax relief (especially for very high earners), hefty tax charges if the total size of your pension fund grows beyond the ‘Lifetime Allowance’ limit, and the fact that you won’t be able to access your pension until you are 55 (rising to 57 in 2028). Your financial planner will discuss these with you based on your circumstances.

Invest for your future

When you’ve maximised the allowances from your pension fund, or you want to be able to access your funds without the restrictions of a pension, there are other investment options to consider.

• ISAs – You can save up to £20,000 within an ISA each tax year and enjoy a tax-free return as well as being able to withdraw your money without penalty or tax
• Investment Accounts – These are similar investment tools to an ISA but without the tax benefits. Income and gains are taxed as they arise, although careful management and use of allowances can help to minimise this
• Investment Bonds – Single-premium bonds issued by life insurers are ideal for gifting or placing money in Trust. There is no personal tax payable while the money is invested, although UK bonds deduct a small amount of tax within the funds. You can withdraw your original capital without tax (up to 5% per year) and will eventually be taxed on the profit if you encash the bond.

Provide for the next generation

Once you have met the financial requirements to reach your own goals, you may be thinking about how best to provide for your family.

• Gift money outright – Most gifts will remain in your estate for seven years
• Smaller gifts of up to £3,000 per year – These are immediately exempt from tax
• Deed of Variation – You can enact a Deed of Variation within two years if your lump sum is from an inheritance. This allows the money to be passed to someone else, bypassing your estate completely
• Set up a trust – There are several options for placing money in Trust. These vary in flexibility and tax efficiency but broadly allow you to ring-fence funds for your beneficiaries without giving up full control. Trusts can be highly complex, and you should obtain qualified advice

If you’ve received a significant lump sum, a financial planner will be able to help you invest it wisely to meet your goals as well managing any tax liabilities.