Did you just receive a sizeable amount of settlement money? It’s probably an emotional time for you, but you’re also thinking, “What should I do with all this settlement money?” Cashing in a half a million or a million dollar check can be quite scary and intimidating. Here at District Capital, we work with clients in the same situation. And if you’re in the same boat, read on for our 5 tips on what to do with your settlement money!
We will be discussing the tax implications, where you should keep the money, whether you should consider giving some to your family, how to best invest the funds, and finally, big picture-wise, what to do with your settlement money.
Tip One: Settlement Taxability
The first question you may have in mind is “is the money taxable?” This really depends on your situation. If it’s a settlement from a personal or physical injury, it’s usually non-taxable. Emotional distress settlement awards are typically non-taxable if the distress is attributable to a physical injury or physical sickness. Car accident injury settlements are usually non-taxable.
What is typically taxable are lawsuits about lost wages or punitive damages, which are damages assessed to punish a defendant. So it really depends on your specific situation. It’s best to consult your lawyer, a tax attorney, or a CPA.
Tip Two: Where to Keep the Money
The second question you may ask is, “Where should I keep this settlement money?” While you’re still trying to figure things out, you may want to keep it in your bank account. Now, instead of letting it sit in your checking account and doing nothing, you may consider opening and moving it to a higher yielding savings account, so it can earn a little bit more interest.
Now, after the dust has settled, then you can start thinking about best tax advantaged accounts or strategies to maximize this opportunity. So let me share with you three things that you can consider.
The first one is funding your Roth IRA. If you’re no longer eligible to contribute to your Roth, a backdoor Roth IRA can be another strategy to consider. Roth is a great way to grow a small part of your settlement money tax-free.
Another great way to grow your money tax-free, which not a lot of people know about, is contributing to a health savings account, or an HSA. Now, not everyone is qualified to contribute to an HSA, so make sure you watch our video on HSA versus FSAs to know what’s right for you.
The bulk of your settlement money is probably going to go to a brokerage account, which is the third type of account that you can consider.
Tip Three: Giving Money to Family
Another common question that comes up is, “Should I give money to my family?” Your family members or relatives may not necessarily be in the best financial situation, so I totally understand if you feel the urge to help them out. There is nothing wrong with that. Or maybe they’re financially ok,, but they’ll still come knocking at your door. Maybe your brother-in-law will ask, “Hey, can I have $10,000 to help me buy a truck?” What’s $10,000 compared to half a million or a million dollars that you just received.
While there is nothing wrong with giving, it’s best for you to have a holistic plan first on what to do with your settlement money before making these types of decisions.
Tip Four: How to Invest Settlement Money
Another common question that we get is how best to invest this settlement money. Investing can be a great way to grow this pot of money over time, but there are so many investment options out there it can be overwhelming. And a lot of them carry hidden fees. To give you an idea on the extent of these hidden fees, in 2014, the White House released a report revealing that these hidden fees and hidden commissions are costing middle-class families $17 billion a year. $17 billion going from Main Street to Wall Street!
So it’s really important to educate yourself. You can start by reading about index funds, which are mutual funds that have really low fees. This means to get to keep more of your money. One popular set of index funds are Fidelity index funds. Make sure to check out our blog on Fidelity index funds for beginners.
There are index funds for stocks, for bonds, for emerging markets. There are all sorts of index funds, so you want to make sure that you educate yourself on what’s the best way to invest that settlement money. If you’re thinking about investing in a real estate property, feel free to also check out our video on how to calculate the rate of return on a real estate property, so you know exactly what you’re getting into and you know, more or less, how much money you can potentially make in this investment.
Tip Five: Overall, what should you do with the settlement money?
The fifth and final question that I’d like to help answer is, “What should I do with the settlement money?” I would like to urge you to find some quiet time and reflect on your life goals. What is important to you? What brings you joy? And then think about how you can use the settlement money as a tool to help you live your best life.
For example, do you get energy from being closer to the water, and maybe you’ve been thinking about buying a vacation home that’s close to the water? If you have a child, do you want to pay for your son or daughter’s college? Do you want to use this opportunity to enable you and your family to retire early or maybe switch to a lower paying job that’s more fulfilling for you?
After you reflect on these life goals, you can think about surrounding yourself with a team of experts to help you implement that plan. I would suggest starting with your quarterback, which is a fiduciary financial advisor.
A fiduciary financial advisor is not your common advisor. The typical advisor that we know of are the ones who try to sell you insurance products or annuities that you may not necessarily need. A fiduciary financial advisor will act in your best interest, we’ll work with you in examining and honing that life goal of yours and creating a holistic and comprehensive plan to implement that.
Additional settlement money questions that you may have:
– What do I do with a large settlement check?
Your financial goals and situation will dictate how you use a large settlement check. Working with a certified financial advisor will help you come up with a settlement check plan tailored to your unique needs. The money will then be less likely to be used on impulse. We share our top 5 tips on what to do with your settlement money in the blog. There are many options including (but not limited to):
- Pay off any debt: If you have any debt, this can be a great way to pay off all or as much of your debt as you want.
- Create an emergency fund: If you don’t have an emergency fund, using some of your settlement money to create one is a great idea. Best practice is around 6 months’ worth of living expenses so that if an emergency arises you won’t need to take out a loan or be in debt.
- Invest the money: You may want to invest in education, a home, a business or something similar.
- Save for retirement: You can take this opportunity to put some money aside for the years ahead when you are no longer working.
Your settlement money plan will probably include a combination of the above options. Take some time to think through your financial goals and how your settlement money can be used to achieve them.
– Do you have to pay taxes on settlement money?
If it’s a settlement from a personal injury or physical injury, it’s usually nontaxable. Car accident injury settlements are usually nontaxable. Lost wages and punitive damages (damages assessed to punish the defendant) are typically taxable. Every settlement case is different depending on the nature of the case and there is a possibility that you will have to pay taxes. Before you finalize any settlement, it’s best to get advice on taxes so that you are prepared. You can consult with a credentialed financial planner or tax specialist to check your settlement money tax liability.
– Can you invest settlement money?
Investing your settlement money can be a great opportunity to benefit from compound interest over time, watch your money grow, and get one step further to achieving your financial goals. While some settlement money is tax-free at the start, once you invest the money into things such as stocks or bonds, then the dividends earned are fully taxable.
– How can I protect my settlement money?
There are several things that you can do to protect your settlement money. First, you can keep your personal injury settlements separate from all other forms of income and keep that money in a separate bank account. This will prevent creditors from being able to take that money away from you in the future.
Another option is to use a prepaid credit card. You can use this to pay for your bills and other expenses without exposing it to creditors.
Our last tip to protect your settlement money is to make sure that you keep records of everything to do with your settlement money. This includes information such as where the settlement money came from, when you received your check, and how you spend the money.
– How are personal injury settlements paid out?
How your personal injury settlements are paid out is up to you. You can choose between a lump sum or a structured settlement. A lump sum can be a great option if you have a large amount of debt to pay off or if you want to invest all of the settlement money. A structured settlement can be a great option if you are worried about spending all of the money at once.
Need help with your settlement money?
You probably have a lot more questions to ask on what to do with your settlement money. Feel free to schedule a free discovery call with one of our financial advisors to go through your personal situation.
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.