Smart Ways to Handle a Windfall
May 18, 2015
We’ve probably all dreamed about winning the lottery or getting some other windfall of money. An inheritance, sale of property or business, divorce settlement, or insurance settlement could all result in a large amount of cash. The wise management of a windfall requires that you complete a comprehensive financial plan first, before you make any impulse purchases or make gifts you might later regret.
Here are several things that you should do first:
- Hit the pause button – especially if your newfound wealth is a result of the sudden death of a family member. Assets such as life insurance proceeds, retirement plans, and joint checking accounts pass to the named beneficiary or surviving owner, bypassing the probate process. You will need to pay the final expense costs right away, but take 6 months or more to grieve before making any other decisions. I’ve worked with several clients who made decisions to rollover pension plans within a few weeks of the death of a loved one. These premature decisions later led to unnecessary tax and penalty issues.
- Interview professional financial advisors who can help you work through a financial plan. A trained financial planner will help you create a new budget and cash flow plan, an emergency fund, personal investment and asset allocation strategy as well as a risk management strategy. Additionally, they will also help you set new financial goals and plan for taxes. Generally, newfound wealth changes how we feel about investing. Most of us tolerate risk less as our nest-egg increases over time. Post-windfall investors generally have a significant change in how they look at risk – moving from an aggressive investment style to a wealth preservation style or income-seeking style emphasizing fixed income investments.
- Consult with a Certified Public Accountant (CPA). Figure out the tax implications before you start spending money. There is no free lunch in most cases where there is newfound wealth. Answer the question about how much tax you will pay, first. You may want to consider paying off your home mortgage - don’t do it until you have consulted with a CPA. Taking funds out of a taxable investment to pay off a tax-advantaged debt requires careful calculation.
- Get your estate in order. Your estate planning attorney should help you update your will, powers of attorney, trust documents, and any other legal documents.
- Be smart about debt. It’s a no-brainer to pay off credit card debt and other debt that has no tax benefit if you have assets that will not be taxed when used to pay off debt.
- Update your giving strategy. If you have charitable intent, consider the smartest ways to give to your favorite charities and reap tax benefits. There are many charitable giving strategies, such as charitable remainder trusts, charitable lead trusts, and donor advised trusts.
- Avoid loans and gifts to family and friends before you have a plan. Most of us are fairly generous and want to help our family. If a friend or family member can’t get a loan from a traditional source, such as a bank or mortgage lender, then it’s not a good idea for you to make them a loan. They can’t get a loan because of their poor credit history. Worse than giving them a loan, is co-signing on a note or guaranteeing a loan for someone. A co-signer or guarantor is on the hook for the entire loan.
- Consider an extra layer of insurance protection. Your new wealth could make you a target for lawsuits. An “umbrella” policy covers personal liabilities above the typical limits on your home and autos.
Once you have considered the practical issues of newfound wealth and have a plan, you will be in a position to fund life and family goals that can make a difference for the current and future generations.
CFP®, FLMI, Annuity Product Manager
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