The biggest raise you'll ever get

Dan Kadlec is co-author of The Power Years, a guide for boomers. E-mail him at boom_years@moneymail.com.

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(Money Magazine) -- The oldest of my three children started college this year, prompting me to flash forward to the day when my kids have all left home and the expenses of child rearing - from piano lessons to orthodontics, summer camp to undergrad tuition - are firmly behind me.

Granted, with two still in high school and the other just a university freshman, it's a little early for me to think about such things in earnest. But I can't help myself; it's exciting.

Yes, this time of life may be bittersweet. Reduced expenses will come with the emotional baggage of living in an empty nest and experiencing a few more aches and pains from aging. Financially, though, this turning point may amount to the biggest pay raise you or I will ever get.

Don't botch it. Here are some strategies for making the most of your empty-nest windfall.

It's simple math: A household of two doesn't have the same financial needs as a household of four or five. Some of the savings will happen automatically - for instance, lower grocery and clothing bills once you're no longer meeting the needs of ravenous, trend-conscious teenagers.

But others require thought and action on your part. If you find, for example, that you're rattling around in a big empty house, maybe it's time to think about downsizing and reaping the savings a smaller home may bring.

If you're free of tuition bills and your mortgage is paid off as well, you may need less life insurance. And if your children have left home for good, for goodness' sake, don't continue to carry them on your auto insurance policy.

But as you're lightening up on some types of coverage, think about adding another: long-term-care insurance, which pays for nursing home and some at-home health care. This is costly coverage (typically $2,000 to $3,000 a year) and most people never need it.

But if you have a history of devastating illness in your family and an estate of at least $500,000 or so that you'd like to preserve for your heirs, this policy can buy you peace of mind.

Your savings may not amount to much at first, especially if your nest is emptier but not yet totally empty - that is, an older child is out of college and on her own, but you still have one or two in school or at home. So it's easy to miss the fact that you have more money to work with.

"Most people don't realize this is a big planning moment," says Ellen Rogin, a financial planner at Strategic Financial Designs in Northfield, Ill. "If you don't think about what to do with the extra cash, the money will just disappear into spending."

First step: Sit down with pen and paper or an Excel spreadsheet and try calculating how much cash has been freed up. You probably know, almost to the dollar, the amount you're saving by not paying tuition anymore.

But how much less a week are you spending on groceries and takeout? How about sporting equipment and fees for guitar or dance lessons and other extracurricular activities? The kids' clothes? Furnishings for the dorm room? Their cell phones? These seemingly minor expenses, tallied together, probably add up to several thousand or more a year.

Figure you've probably got more like 80% of that amount to work with - your calculations won't be precise and some of that cash will be subsumed into the rising cost of everything - and make a priority list for what to do with the money.

Goal No. 1: Paying off your nonmortgage debt. After all, as you get closer to retirement, you can't afford to be in the hole. Be systematic. At the time you used to write your tuition check, Rogin advises, write checks equal to at least half that amount and apply it to your loans.

Start with variable-rate debt, like credit cards and home-equity lines; then tackle fixed-rate obligations like auto or college loans.

You'll also be able to focus on investing for retirement like never before. Even before you've paid off all your consumer debt, aim to put at least 20% to 40% of your newfound cash into long-term savings.

If you're already maxing out your 401(k), take advantage of the catch-up provision that lets employees age 50 and older kick in an additional $5,000 this year. Or fund a Roth IRA (if you and your spouse earn $159,000 or less, you can put in $5,000 this year; or $6,000 if you're 50 or older).

"The numbers say you should pay off your debts completely first," says Cleveland financial planner Ken Robinson. "But we don't run on numbers. We run on emotion, and seeing your savings grow is incredibly empowering."

Go ahead and spend some of your wind-fall. Gulp. That's not easy for me to write. Spending is most people's natural inclination. They don't need encouragement and, if anything, they're apt to go overboard.

Yet you've earned some fun. A good life is about balance, not denial. So live a little. The key is putting a limit on the reward. "I could see spending 10% or even 20% of a monthly windfall," says Robinson.

If you have ample savings and no debts, it's a good time to consider how you might share some of your assets in the future to promote the things that matter most to you. "You want to put meaning into your money," says Howard Kramer, a financial planner in Plantation, Fla. "Don't just spend it."

Start by opening a discrete account for charitable giving - a simple money-market fund will do - and depositing a carefully considered portion of your empty-nester windfall into it every month (say, 10% to 20%).

Or contribute to a donor-advised fund, like the Fidelity Charitable Gift Fund or Vanguard Charitable Endowment Program, which gives you a tax deduction on money you'll invest and give away later.

Then think about the kind of impact you'd like to have. Maybe you hope to help fund a future grandchild's 529 plan. Or assist your kids with the down payment on a house.

Or maybe you want to spend your charity bucks on a volunteer vacation (for destination ideas, check out voluntourism.org or globalvolunteers.org). Give it some thought, and prepare to use your assets in a way that reflects your values.