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What to do with a lump sum of money

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It’s a happy thought, but not without its worries: what do you do if a lump sum of money lands in your lap? Here we explain your options.
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Man holding an open suitcase full of money

We all dream of being gifted a windfall, but after the initial rush of excitement wears off, then comes the daunting question of what to do with the money. 

Do I save or invest a lump sum?

Let’s say you find yourself £20,000 richer, after popping a few corks comes the serious business of considering your options. Clearing any debts is a good start. But where do you go from there, do you save or invest?

Where’s best to save a lump sum of cash? 

If you want your money to grow, savings are an obvious answer. Although you’ll need to pick the savings vehicle that’s best suited to your requirements. Here are the main options: 

Premium Bonds

Premium Bonds offer a safe haven for a windfall as they are completely safe, being government-backed. 

You can buy up to £50,000-worth of premium bonds in multiples of £25. While you don’t earn interest, each month thousands of people win tax-free prizes from £25 upwards, and two lucky bondholders scoop a £1 million. 

If you’re looking for a bit of fun and a safe berth while you figure out what to do long-term, Premium Bonds could appeal.

Easy-access savings accounts

With instant- and easy-access accounts you earn interest on your savings, making deposits and withdrawals as you need, without penalties. 

This flexibility comes at a cost, as the interest rate on savings is usually lower than what’s offered elsewhere. However, if you’re uncertain about your finances or what to save for, it’s a good starting point. 

Regular savings accounts

Regular savings accounts are worth considering if you want to save toward a specific goal, such as a wedding or home improvements. 

You can expect a higher rate of interest than you’d get with an easy access account Providing you make the minimum regular deposits. However, keep an eye on the interest rate, which is often slashed after a year.  

Fixed-rate savings accounts

With fixed-rate savings accounts or bonds, your savings earn interest at a pre-determined rate that’s guaranteed for the duration. The longer the term, which is typically between six months and five years, the higher the interest rate. 

You can expect higher interest rates than those offered on other types of accounts because your money is tied up. Should you make any withdrawals, you’ll incur hefty fees that will probably wipe out your interest earnings. If you’re saving for a home deposit, for example, and aren’t concerned about the lack of access to your cash, those attractive interest rates could swing it. 

Notice savings accounts

As the name suggests, you need to give notice before you make any withdrawals from a notice account, in some cases of up to 120 days. 

Historically, providers offered attractive interest rates to entice would-be savers. Less so now, with better deals regularly offered by alternatives. For instance, Aldermore currently offers 1.20% on its 120 Day Notice Account, whereas Principality BS Learner Earner (Issue 3) regular savings account pays 2.75%.

Should you find one with a decent interest rate, and can see the benefit of a barrier to knee-jerk withdrawals, notice accounts may appeal. However, you wouldn’t want one if you needed cash in an emergency.

How does the Personal Savings Allowance work?

The Personal Savings Allowance (PSA) allows most of us to earn some interest on our savings tax-free, which means: 

  • the first £1,000 of interest earned on savings is tax-free for basic rate taxpayers 

  • the first £500 is tax-free for higher rate taxpayers 

  • additional rate taxpayers don’t qualify for a PSA

PSA sounds like a big plus, but bear in mind that to earn £1,000 of interest you’d need a lot more than £20,000 in savings. 

What about ISAs?

Cash ISAs are identical to normal savings accounts, it’s just that you don’t pay tax on any interest you earn. Again, this sounds great, but given they tend to pay relatively low interest to offset the potential tax benefit, you’d need a lot in your ISAs before interest earnings exceed your PSA. 

What are the investment options for a lump sum?

Should you come into money, you may feel the returns on savings are less than inspiring and want to invest

If so, there are several options, from Stocks and Shares ISAs to Pensions. Of course, you should take independent financial advice before making any decision, but here are a few key issues you should consider.

Your appetite for risk

Investments always come with a warning that you could lose all or some of your money and some investments are riskier than others, meaning potential gains and losses are greater

Your age

Stocks and shares holdings are typically designed to go untouched for five to eight years. This makes them more suitable for younger people, who can afford to weather downturns in the market

Your current financial portfolio

If you’ve already got plenty saved or invested, you need to think carefully about where your money is. The Financial Services Compensation Scheme only protects up to £85,000 held with one financial institution if it goes bust, the advice is to spread it around 

Your ambitions for the money

If you’ll need the £20,000 for a big outlay, such as a home deposit, relatively soon, investing would be far riskier than saving. There again, investing may be a sound bet if you’re looking to save for your retirement

Should I overpay on my mortgage?

Paying extra to help reduce your mortgage more quickly – and pay less insurance in the process – is an alternative to saving or investing. There are a few things to consider, though:

Pros of overpaying on your mortgage

  • clearing more of what you owe your mortgage lender is a great feeling

  • you’ll pay less in interest – as you’ll wipe out your debt sooner

  • you’ll pay less in tax, as you won’t pay tax on interest that isn’t applied to your mortgage

Cons of overpaying on your mortgage 

  • you lose access to the money, meaning it’s not available to you to cover an emergency unless you remortgage

  • you could make more by saving or investing than what you’d save in interest through early mortgage repayments