The Silver Linings Playbook
A few years ago I wrote a short, pithy blog about windfalls and what to do when you experience this happy event. At the time, I was thinking mostly of “micro” windfalls — extra pay for overtime work, perhaps a tax refund. But sadly, I am now speaking to a lot of people who are receiving rather large windfalls from severance pay and unused vacation time following the loss of their employment. And yes, it is sad because every one of them would gladly hand it back to keep doing the work that they love.
But here we are and decisions must be made. What do you do when you have a five (or even six) figure of money drop into your bank account?
For openers, if you are not re-employed (and need to be), this is not a windfall. It’s just your paycheck, coming all at once. For those who will be experiencing this as a windfall, however, the rubric that I proposed earlier still holds: Fund your financial goals first. Of course, this assumes that (1) You have articulated these goals, and (2) You have ordered these goals by priority. Let’s break that down.
Will you be shocked when I say that the first goal must be fully funding your emergency fund? Of course it is. And as I have said before (and you may be feeling quite viscerally), the old “three months of expenses” rule is likely just not enough.
Next up on the priority list is your sinking fund. Looking out over the landscape of the upcoming year, what are the big expenses that you know are coming and can’t be accommodated within your typical cash flow? It may be summer vacation…or an exciting new water heater. But you will need to balance the needs and the wants in your sinking fund with…
Your debt. Your excuse for carrying a credit card balance is now gone. Pay it off. Lower interest rate non-mortgage debt (for my purposes, let us say anything with a single digit interest rate) can also be a payoff priority now, if your retirement savings plan is up to snuff.
With the above accomplished, now we can move on to the sexier stuff.
How’s your retirement saving looking? If you have fallen behind in your progress to achieve your savings goal, a one-time infusion to your retirement savings can put you back on track. (Side note: Do you know what “on track” actually looks like?)
This may require a bit of thought in the execution. You may be over the earnings limit to contribute to a Roth IRA. Or the amount that you want to “power fund” is more than the contribution limit ($7000 in 2025).
The easiest option is to invest this lump sum in a regular, non-retirement (i.e., taxable) brokerage account. True, it will not benefit from the tax features of a retirement account…but then again, you won’t have to deal with any restrictions on withdrawal. (Are you anticipating an early, pre-59 ½ years old retirement?) There are fancy strategies like backdoor Roth contributions, but let’s not get too wrapped around the axle of tax optimization. And let me just say this: Do you think that very wealthy people are suffering in retirement because they don’t have an IRA?
Another tactic might be to increase your workplace retirement account contribution to the maximum allowed, offsetting this decrease in your paycheck with your windfall.
What have you got going on in your life before retirement? We have arrived at the “dealer’s choice” point. This might be funding a 529 account for your child’s college years. This may finally be your opportunity to make a down payment on a new home. Does it make sense to pay for a traditional-to-Roth IRA conversion? Can you imagine (yet another) career switch down the line that will reduce your income, and so needs to be “pre-funded”? Or it may even be (Shudder! Horror!) a completely discretionary big-ticket purchase like a new car or kitchen.
There are two keys here. One, take your time. Park the windfall in a nice high yield savings account or money market account until you have decided. There is no rush whatsoever. Two, once you have decided, match the timeline for your goal with your investment choice. If you are house hunting, this windfall will not find its way to the stock market no matter what it is doing today. (I have not checked.) If your child is a toddler and this is for their university years, or your planned career switch is sometime in the 2030s, then you can have a conversation about investment options that involve more risk.
It's so tired to say that there is a silver lining to every cloud. Severance pay, or especially an inheritance, may not feel like that at all. And behavioral economics tells us that there will be a natural temptation to treat this windfall like a bonus, which is not always conducive to the best decision-making. Your best first play off the line of scrimmage might be to just punt the ball.
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