Receiving a financial windfall can be thrilling, as it’s rare to come across a large, unexpected lump sum of money. But while your first impulse may be to imagine all the fun things you can do with it, you’ll want to be mindful about how you use funds to ensure you get the most financial benefits.
There are many ways a windfall can improve your life. It can help you repay debt, make a dream purchase, or boost your savings. However, it’s also crucial to know the financial implications of receiving a one-time financial gain, including the tax consequences and what happens to the money if you’re in the midst of bankruptcy or a consumer proposal.
Let’s TalkWhat is a financial windfall?
A financial windfall is an unexpected, often large, amount of money you receive. It could be an annual bonus, income tax refund, government-funded grant, or proceeds from selling your personal work. It could also be an inheritance, lottery winnings, or gains from selling personal belongings.
The source of financial windfall matters because there may or may not be tax implications for the extra cash. It often makes sense to hold onto a substantial portion of a windfall until you have filed your taxes for the year in which you received it.
What can you do with a financial windfall?
A financial windfall can tremendously impact the rest of your life. Significant windfalls like inheritances or lottery winnings are rare events, and managing those funds well can improve your financial situation in the long run.
When planning what to do with your windfall, first review your current financial situation to see where you stand. Then, set financial goals in order of importance based on your circumstances. A wise approach is to split your finances into the following categories: debt, savings, and spending.
Debt
If you have outstanding debts, one of the best financial decisions you can make is to use your windfall to pay them down. It often makes sense to pay off debt before saving, except to put together an emergency fund. The sooner you clear your debts, the less interest you’ll pay.
It makes sense to prioritize high-interest loans first, such as:
- Credit cards
- Payday loans
- Lines of credit
After that, consider student loans, car payments, and your mortgage, though be aware of penalties for paying early.
Savings
Setting up or adding to your savings can help improve your long-term financial stability and success. Whether your goal is to save for your retirement, contribute to an RESP for your kids, or set up an emergency fund, a financial windfall can go a long way toward helping you reach that finish line.
If you plan to add your windfall to an RRSP or TFSA, be aware of your annual contribution limits. Over-contributing can lead to tax penalties.
Consider speaking with a financial planner if you need help creating a long-term investment plan.
Spending
Being financially savvy with a windfall doesn’t mean you can’t enjoy it. Yes, it’s wise to dedicate the funds to your savings and debts first. But with careful planning, you can still have enough money left over for a new wardrobe, vacation, extra Christmas gifts, or anything else you wish. If you’re feeling generous, you can use some of your windfall to make charitable contributions.
What happens to a financial windfall in bankruptcy?
As debt professionals in the GTA, we’re often asked what will happen if you file for bankruptcy and then win the lottery. While winning the lottery is highly unlikely, the money you receive will have to be turned over to your trustee for the general benefit of your unsecured creditors. This is also true of other windfalls such as inheritance or lawsuit settlements.
What happens to a financial windfall in a consumer proposal?
In a consumer proposal, you repay your creditors a portion of your debts over five years with equal monthly payments. It’s an effective way to erase your debts in Canada if you earn a steady income but can’t keep up with your debt payments.
One of the advantages of a consumer proposal is that your monthly payment stays the same even if your income increases. Where the extra money comes from doesn’t matter: it could be a raise from work, a new side hustle, and, of course, a windfall.
When you receive a sudden influx of cash during a consumer proposal, you do not owe any of that money to your creditors. However, you can use the windfall proceeds to pay off your remaining balance. By settling your consumer proposal early, it’ll clear from your credit report sooner, making it easier for you to qualify for loans in the future.
How a financial windfall can create a tax debt
Some financial windfalls count as taxable income in Canada. However, because the government doesn’t automatically take its cut before you receive the money, you can wind up with a substantial tax bill when you file your taxes.
When you receive an unexpected sum of money, you’re responsible for withholding the taxable portion and remitting those funds to the CRA (Canada Revenue Agency) by the deadline. Failure to do so can result in income tax debt.
The potential for getting into tax debt is why it’s critical to determine if your windfall is taxable. If you discover that it’s subject to tax, you can take precautions to ensure you don’t spend the entire amount.
However, suppose you’ve already spent the entire amount and are facing or worried about the consequences of owing money to the CRA. In that case, it may be time to explore your options for income tax debt help.
Taxable vs. non-taxable windfalls
The difference between taxable and non-taxable windfalls in Canada depends on the source of the money. According to Canada’s Income Tax Act, income is taxable if it comes from:
- Employment earnings
- Business income
- Investment income from property or other assets
- Capital gains
It’s also worth noting that certain government benefits are also taxable. This includes Canada Emergency Response Benefits (CERB) and Canada Recovery Benefits (CRB). CRB tax payments are based on your annual income for the year you received the benefit. You can find out more about income limits and Canada recovery benefits to learn how much you may need to repay the CRA.
There are also a number of non-taxable sources of income, including:
- Lottery winnings
- Gifts and inheritances
- GST/HST credits
- Income tax refunds
- Canada Child Tax Benefits
- Child assistance payments
- Proceeds from a life insurance policy
- Income from a TFSA
- Most compensation for a personal injury
This doesn’t mean that these funds aren’t taxed at all. For example, inheritances are typically taxed as part of the deceased’s income at death. Whatever remains passes on to the beneficiaries.
The source of a financial windfall and whether it’s taxable may not always be obvious. For example, if you work as an artist and sell a painting, the proceeds will count as taxable income. In such cases, consider seeking advice from a tax professional.
How to Deal with CRA Debt from a windfall
Many Canadians make the mistake of spending their windfalls without accounting for potential tax consequences, only to be caught off guard by a sizable tax bill. Ensure you set aside a suitable portion of windfall that the CRA considers taxable income. That way, you’ll be prepared to pay the required amount to the CRA when you report the windfall on your tax return.
If you find out that you owe taxes on a financial windfall you have already spent, you may be indebted to the CRA. Depending on the amount you owe, you may struggle to come up with the money. If that’s the case, contact a Licensed Insolvency Trustee to explore solutions for dealing with your debts. You can book a free consultation to discuss your situation and get advice on moving forward.
Don’t let a financial windfall turn into a financial disaster. Create a sensible plan for how you’ll spend and manage the funds, and become familiar with your tax obligations. And if you’re currently going through insolvency, ensure you know the implications your lump sum of cash will have on your bankruptcy or consumer proposal.
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