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.
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?
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 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.
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 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.
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.
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.
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.
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.
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
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
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
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
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:
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
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