When reading this blog, please note that your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.
Okay, picture this: you’ve just won a life-changing amount of money on the lottery (let’s say £100k). After the party and champagne’s finished, you spend half on a house deposit, leaving yourself with the prospect of investing £50k.
Although this is a nice problem to have, you soon realise it’s not exactly a straightforward one, either.
Do you put it in a savings account, for example? Or maybe a Stock and Shares ISA, where you can invest up to £20,000 per tax year without paying tax on your gains? (Although your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.)
The good news is that there’s no right or wrong answer because, ultimately, there’s no one-size-fits-all solution. And to make the most of a lump sum investment, it’s important to start by understanding what it actually means.
What is a lump sum?
As the name suggests, a lump sum is a large amount of money paid as a one-off, which can be from:
- An inheritance
- Winning a prize
- Selling property or other assets
- A promotion or work bonus
- Redundancy pay
It differs from regular saving in that you receive the money in one go. For example, instead of putting £100 away monthly for 10 years, you’d receive £12,000 there and then.
What could you do with a lump sum?
What you do with a lump sum will largely depend on a variety of factors, including:
- The economy and interest rates at the time
- Your personal circumstances and needs
- Your short and long-term financial goals
- Your appetite for financial risk
It’s also particularly important to ask yourself when you’ll need access to the money.
If you’re building your emergency savings fund, for example, then you might consider a digital savings account with easy access to your money. With all that in mind, here are five different ways you could make the most of using or saving a lump sum.
1. Clear Debt
Although debt can cause financial problems and worry, not all debt is considered bad debt. Essentially, it could depend on a number of things, such as:
- The interest rate you're being charged
- How long you're borrowing for
- The cost of repayments
For financial peace of mind, however, resolving any outstanding debts could be a good use of your lump sum. And, if you’ve still got some of your lump sum left over after doing this, you could still pursue some of the other options below.
2. Build your emergency fund
You know when you're hit with an unexpected bill and panic about where the money's going to come from? Well, that’s exactly what an emergency fund is for: to help you deal with any financial curveballs life throws at you.
With an emergency fund, the rule of thumb is to save enough to cover between three and six months’ worth of expenses.[1]
However, it really depends on your personal circumstances, so figure out how much is enough for you. If an emergency does happen, you’ll likely need to access the money quickly. And, with that in mind, you’ll probably want to look at an easy or instant access savings account.
To make the most of your lump sum investment, it's always worth shopping around and comparing interest rates to get the best deal.
3. Put it in a high yield savings account
If want to get a potentially higher interest rate when saving a lump sum, then a high yield savings account could be for you.
Whether you're putting £50k in a digital savings account or £100k with a high street bank; a fixed-rate account is a type of savings account with an interest rate that stays the same — but you have to lock away your money for a certain amount of time.
You’ll also usually have to pay fees for early withdrawal. So, make sure you shop around, understand the terms, and can afford not to have immediate access to that money. If you are willing to stay the course though, then a high yield savings account could well be worth exploring.
4. Invest in a Stocks and Shares ISA
At Wealthify, we’ve always prided ourselves on the fact that you can start investing with us from as little as £1 with most of our Plans. But if do you have a larger lump sum investment, then you can still invest with us!
And, if you don’t need access to your money anytime soon, then a Stocks and Shares ISA or investment ISA could be a good long-term option.
The main benefit of having a Stocks and Shares ISA is that it lets you invest tax-efficiently, in that you don’t need to pay tax on any returns you make (however, one thing to be aware of is that there’s an annual ISA allowance).
With that in mind, why would you consider investing it in the first place?
Well, when it comes to performance, let’s say you’re investing an inheritance worth £20,000 in a Wealthify Stocks and Shares ISA.
After 10 years, you could end up with £30,230.[2]
Leave it invested for 20 years?
Then that figure could rise to £40,588.[3]
Essentially, the longer you stay invested for, the better chance you could give your money to recover from any dips caused by things like market trends and economic events.
Please remember the value of your investments can go down as well as up, and you could get back less than invested. Past performance is not a reliable indicator of future results.
Your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.
5. Boost Your Pension
Last but not least, you could use a lump sum investment to give your pension a nice boost.
If you're looking for a tax-efficient way to make your own pension contributions, a SIPP (Self-Invested Personal Pension) could provide more control and flexibility over your retirement pot (with a Wealthify SIPP, for example, you can get started with a minimum deposit of £50).
For both employed and self-employed people, paying into a SIPP could come with many advantages, including:
An instant 25% top-up for personal contributions: This nifty perk could help maximise your potential long-term returns when saving a lump sum. So, if you’re a basic rate taxpayer, you’ll only need to contribute £80 for a £100 contribution. The government will pay the remaining £20 in tax relief.
More choice: With workplace pensions, you can't always choose how your money is invested. When investing a lump sum into a Wealthify SIPP, the opposite is true, because you can choose your risk level and investment style. You could choose to have an Ethical pension if you wanted too.
No contribution limits: Each year, you can put as much into your SIPP as you want — great news if you’re saving a lump sum. For the current tax year, however, you'll only receive tax relief up to £60,000 or 100% of your income (whichever is lower). This tax-efficient portion is known as your pension annual allowance or pension contribution limit.
Transferring a pension comes with many different rules, so it’s worth being aware of them – as well whether it’s right for you depending on how close you are to retirement age – if you want to move your money somewhere else. You can read more about this by reading our blog featuring everything you need to know about pension transfers.
At the start of this guide, we said that knowing what to do with a lump sum can sometimes feel daunting. If you've made it this far, however, we’re hoping you'll find it just a little bit easier!
Wealthify does not provide financial advice. Please seek financial advice if you are unsure about investing.
Please remember the value of your investments can go down as well as up, and you could get back less than invested. Past performance is not a reliable indicator of future results.
Your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.
References:
- https://www.moneyhelper.org.uk/en/savings/types-of-savings/emergency-savings-how-much-is-enough
- This is the projected value for a Confident Plan (Medium Risk Plan) with an Original theme. This is only a forecast and is not a reliable indicator of future performance. If markets perform worse, your return could be £21,409. If markets perform better, your return could be £42,275. Values correct as of 21/11/23.
- This is the projected value for a Confident Plan (Medium Risk Plan) with an Original theme. This is only a forecast and is not a reliable indicator of future performance. If markets perform worse, your return could be £23,980. If markets perform better, your return could be £69,056. Values correct as of 21/11/23.
