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What’s the best way to save a lump sum?

Written By:

Wealthify

Posted:

15/07/2024

Updated:

15/07/2024

Just imagine... It’s finally your lucky day and you’ve won a life-changing amount on the lottery. Do you already know what you’d spend that lump sum on?

This article is sponsored by Wealthify, the online savings and investing service.

Maybe you plan to pay off your mortgage or get on the property ladder, and know exactly what car you’ll treat yourself to with whatever you have left over.

Or maybe you’d rather chuck as much as possible into savings or investments and see how much it could grow (however, do keep in mind that with all investing, your capital is at risk).

In reality, most of us sadly won’t ever win big on the lottery. But there are plenty of other ways you could come into a large amount of money. And if you do, then you’ll want to think about what the best way to save a lump sum (or spend it) could be for you.

For example, do you invest it tax-efficiently through a stocks and shares ISA, pay off some of your debts, or save it for a rainy day?

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What is a lump sum?

As the name suggests, a lump sum is a substantial amount of money that’s paid to you as a one-off, and all in one go – meaning it could be:

An inheritance
A prize you’ve won
Money from selling property (or other assets)
A tax-free lump sum taken from your pension
A bonus from work
Redundancy pay.

But how much money can be considered a lump sum?

Well, it can mean very different things depending on who you ask. It’s simply an amount of money that you wouldn’t usually have and can be something you receive unexpectedly.

So, it could refer to a couple of hundred pounds, a couple of thousand, or even more than that.

What is the best thing to do with a lump sum of money?

As we’ve said, this is a tricky question to answer, and the best way to save a lump sum will depend on a range of factors – such as:

Your current financial situation
What your goals are (and whether they’re short- or long-term as this may effect when you need to access the money)
Economic factors (like market performance and interest rates)
Your appetite for financial risk.

Luckily, there are many ways to grow, save, and manage a lump sum, so you can choose the right one for you based on the above.

Put the lump sum in a savings account

Most of us know how savings accounts work, and if you want to leave a lump sum untouched for a while and give it a chance to keep growing, then it may seem like the obvious choice.

This is because, with most savings accounts, you’ll be paid interest for keeping your cash in them – and if you have a high rate and a large amount deposited, then it could build up nicely over time.

However, there are loads of options available on the market, and getting the best possible interest rate might not be the most important thing for you.

So, here are some things to consider when choosing a savings account to pay your lump sum into:

The interest rate (and whether this is likely to change over time – it may offer a variable rate, a fixed rate, or an introductory rate that drops after the first few months).
Whether you’ll be taxed (with cash ISAs, you can currently save up to £20,000 each year without paying tax on the interest you earn).
Fees or charges (as some providers may charge these in exchange for a high interest rate, or even to withdraw your money from the account).
If it’s easy access or not (again, some providers may charge you to withdraw money from your savings account or require you to keep the money in it for a specific amount of time).

Another thing to consider before choosing to put your lump sum into a savings account is also the impact of inflation on your money.

On paper, your lump sum will grow if you earn interest on it. But if the rate you’re getting from your savings account is lower than inflation, then it could actually lose value over time as you’d be able to buy less with it in the future.

And something else to be aware of is that in the UK, up to £85,000 of your money is protected by the Financial Services Compensation Scheme (FSCS) if it’s kept with a UK-regulated institution – like a bank, building society, or savings or investment provider.

And, just FYI, up to £85,000 is protected per institution and banking licence, and not per account you hold with them.

Invest the lump sum through a Stocks and Shares ISA

If you want an opportunity to potentially beat inflation and have your lump sum grow further, then investing it could be something to consider.

This is because returns (aka, any money you could make from your investments) are impacted by stock market performance, rather than being tied to fixed interest rates (like the gains you earn in a savings account would be).

Plus, if you opt to invest through something called a Stocks and Shares ISA, you can put in £20,000 during the current tax year (2024/25) without paying tax on any of the returns you make.

But, as with all of the options we’ll mention, there are some things you need to be aware of before you decide that, for you, investing is the best way to save a lump sum, such as:

Your personal appetite for risk: Stock markets fluctuate over time due to various factors – this means your investments will also go up and down, and if you sell when prices fall, you could make the losses real instead of giving the markets time to potentially recover.
When you’ll need your lump sum: It’s generally recommended that when you invest, you do it for the long-term (at least three to five years). Again, this is because markets go up and down, and staying invested for longer may give your investments more time to recover from dips.
Your own time and knowledge: Not everyone is a stock market expert or has time to do a ton of research into what to invest in – and these days, neither of these is a requirement as there are plenty of providers (like Wealthify) who will actually do the investing for you.

Boost your pension with your lump sum

Retirement may seem too far away to worry about yet, and you might think that because you have a workplace pension and the state pension, then you don’t need to do anything else.

But it’s worth checking your eligibility for the state pension and when you’ll start getting it, as well as how much you currently have in any workplace pension pots.

After all, do you know how much you need to retire with and whether you’re on track to reach that?

Well, according to the Retirement Living Standards from the Pensions and Lifetime Savings Association (PLSA), for a ‘moderate’ retirement (that includes some luxuries, like a monthly meal out and trips away), a single person currently needs around £31,300 per year.

And if you’re one half of a couple? You’re looking more along the lines of £43,000.

So, it might not hurt to give your pots a boost by paying in a lump sum.

If you wanted to do just that, then you could see if you’re able to do this with any existing pensions you have (from an old job or your current one) or if it’s worth opening a SIPP to deposit it into (this is also called a ‘self-invested personal pension’ or just a ‘personal pension’.

Here are some of the benefits:

You can transfer your pensions: If you have multiple pots from past jobs, then moving them into a SIPP could allow you to reduce your fees (if you choose a provider with lower charges than you’re paying now). It will also make it easier to see exactly how much you have tucked away.

You’ll get a 25% tax relief top-up: This nifty perk means that if you’re a basic-rate taxpayer, you’ll only need to put in £80 for a contribution to be worth £100 (as the Government will pay £20 in tax relief). However, this is only on up to £60,000 or 100% of your income – whichever is lowest.

However, if you do decide that, for you, the best way to save a lump sum is to pay it into a pension, don’t forget that your money will be locked away until you’re 55 (though this is changing to 57 from April 2028).

Take steps to pay off any debts you have

Although you may be tempted to squirrel away your lump sum to give it an opportunity to grow, if you have any debts or loans, then you may want to consider paying those off first.

Now, not all debt is ‘bad’. After all, most of us will have a student loan, mortgage, credit card, or a combination of the three, and these things are simply a part of life for many people.

Despite this, debt can still cause worry and financial problems, as the amount you owe can stack up pretty quickly if you have a lot of different loans and are being charged high interest rates.

So, if you do want to use your lump sum to clear some of these off your plate, here are some things to consider when choosing which debts to prioritise first:

The interest rate you’re being charged
How long your loan term is
The cost of repayments
If there are early repayment charges.

And, if you’ve still got some of your lump sum left over after tackling them, you could still save or invest what you have left over.

If you need help with managing or paying off any debts, please read our article ‘How and where to get help with debt’.

Lump sum considerations: Things to keep in mind

Now you know some of your options when it comes to some of the best ways to save a lump sum and may have already decided what you’d like to do with it.

But before you actually do anything, don’t forget that there may be tax implications to think about (depending on where your lump sum came from).

Here are some of the tax treatments to be aware of:

Pensions: You can usually take up to 25% of what you have saved as a tax-free lump sum. But you won’t be able to access this until you’re a certain age – so check this beforehand.
Inheritance: You may be liable to pay inheritance tax if the value of the estate is above £325,000 (but this is only on the amount above the threshold).
Profits from assets: If an asset you sell (like your home or stocks you hold) has increased in value, you may need to pay capital gains tax or other tax on your investments.
Winnings: In the UK, you’re not required to pay tax on winnings from betting or the lottery.

This is just a quick summary, and not an extensive list of the tax implications for each source. So, if you’re unsure about tax or any of the options we’ve outlined in this article, you may want to seek advice from a financial adviser or visit the Government website for more information.

Thinking about saving or investing your lump sum? Wealthify offers a variety of products that could help it to grow over time – like an Instant Access Savings Account with a competitive, variable interest rate, a Stocks & Shares ISA so you can invest without paying tax on the gains you make, and a Self-Invested Personal Pension so you can save for your retirement in a way that suits you.

As with all investing, your capital is at risk, and you could get back less than you put in.

Wealthify does not provide financial advice. Please seek financial advice if you are unsure about investing.

Your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.