What the merry Widows should do with their windfall

Congratulations if you are one of the lucky Scottish Widows policyholders who has received a windfall. Following on from the Edinburgh-based insurer's £5.8bn takeover by Lloyds TSB, policyholders are receiving an average of £6,000 - higher than most anticipated.

Congratulations if you are one of the lucky Scottish Widows policyholders who has received a windfall. Following on from the Edinburgh-based insurer's £5.8bn takeover by Lloyds TSB, policyholders are receiving an average of £6,000 - higher than most anticipated.

So what do you do with your money? Scottish Widows is offering policyholders a choice of investments, including a new version of the insurer's With-Profits Bond and a European ISA (individual savings account). Yet do not feel that you have to invest in either.

"Don't rush in and take up the funds offered by Scottish Widows," says Pat Connolly, associate director at independent financial adviser (IFA) Chartwell Investment. "Even if you wanted to opt for those funds, you'd get better terms from a discount broker."

Your personal circumstances and the size of your windfall will dictate what you do with the money. A large number of people will only qualify for a basic payment of £500, which does not give much scope for investment. So if you find yourself in this position you may as well treat yourself to a holiday or shopping spree.

However, if you receive a few thousand pounds and don't want to spend it, you could clear some debts - such as an overdraft or outstanding balance on your credit card. Paying off some of your mortgage is another option, reducing the amount of interest you pay during the term of the loan. But make sure you don't incur any penalties for doing so.

If you prefer to invest the money and need to get hold of it in the short term - say within the next couple of years - you should opt for a high-interest savings account with easy access. Nationwide pays 7 per cent interest on its no-notice e-Savings account, for minimum balances of £1.

If you don't need to get hold of the money for five years or so, invest in the stock market. It makes sense to use up your tax-free ISA allowance first - £7,000 this year - or get tax relief by topping up your pension.

Your risk profile will also determine where you invest your money. If you are nearing retirement or just don't want to take on much risk, avoid speculative funds. Vivienne Starkey at IFA Equal Partners recommends the Aberdeen Aggressive Growth unit trust, which contains zero-dividend preference shares. Even if you have used up your ISA allowance already, you can make returns of about 8 per cent per annum, suitable if you are looking for steady growth.

You can also minimise your tax bill by investing in a growth unit trust that produces no income in the form of dividends. Any gains can be offset against your capital gains tax (CGT) allowance - £7,200 this tax year.

Ms Starkey recommends the Gartmore UK and Irish Smaller Companies fund or the fairly volatile Framlington Health fund. As your windfall is an "extra", you may be prepared for more risk than usual.

Mr Connolly recommends Japan and the Far East for higher-risk investors, but suggests you opt for well-diversified funds from fund managers with strong resources in the region. He picks Save & Prosper Japan Growth and Henderson Pacific Capital Growth (previously the Asian Enterprise Fund).

Some policyholders will find that the size of their windfall means they exceed their CGT allowance. If this is the case, you must declare your liability to the Inland Revenue by 5 October 2001 by filling in a self-assessment form, or face a hefty fine.

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

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