How to best manage an unexpected financial windfall. Whether it’s an inheritance, a lump-sum retirement payout, proceeds from a business sale, or winning the lottery, it does not mean making a list of everything you want to buy—the more significant the windfall, the larger the potential problems. Complex rules, difficult decisions, and a range of emotions can cloud your judgment. However, having a process in place can provide long-term financial success and prevent unwise choices that may lead to losing it all.
“Seven in 10 people who suddenly receive a large sum of money will lose it all within just a few years.” (NEFE)
Most people are ill-prepared for a financial windfall. Don’t end up a sad statistic. An abrupt financial change requires a process. Here are the steps you should take if you are in such a situation.
1. Take a step back
DO NOTHING. That’s right, take 30 or 60 days and do nothing. It prevents you from immediately making a decision you may regret – no new cars, vacations, investments, or early retirements. While all of those wishes may be possible, depending on the size of your newfound wealth, it’s essential to plan out a strategy to review everything you want to do.
You also need this timeout to take emotions out of the equation. Emotions and financial decisions don’t mix well. Excitement, guilt, nervousness, fear. It’s a fine line. You don’t want your exuberance to make you reckless, but at the same time, you don’t want fear to freeze you into not making any decisions. Both may be harmful, although in different ways.
Unsolicited advice, can’t-lose investment opportunities, everyone has an opinion, family, friends, strangers. Everyone’s “gotta guy” with a hot investment tip. Your best bet, when possible, is to tell no one except a few trusted individuals. It’s no one’s business.
Take the time to develop a strategy to work through the details in private, and make short-term and long-term plans to achieve those “like to haves,” along with the must-haves of your everyday finances – no debt, positive cash flow, and sufficient savings.
2. Draft your financial windfall team
It is best to get a CERTIFIED FINANCIAL PLANNER™ professional to assist with getting your plan in place. Depending on the complexity of the newfound wealth, you may also need an attorney and a CPA. Doing so could save you time, money, and stress.
Do your homework when selecting your team, check backgrounds and expertise, ask for references, and conduct interviews to determine if they are a good fit.
I recommend a fiduciary, fee-only, CERTIFIED FINANCIAL PLANNER™ professional. Here are some links to help you in your search.
The National Association of Personal Financial Advisors – NAPFA https://www.napfa.org/find-an-advisor#tab=filters
Financial Planning Association http://www.plannersearch.org/
Certified Financial Planner Board of Standards http://www.letsmakeaplan.org/?gclid=EAIaIQobChMI0_v8vrec3gIVUkwNCh2_5wSlEAAYASAAEgKtJvD_BwE
3. Understand the lay of the land
Your team can help you with the details. It’s important to know the type of assets. It could be cash, stocks, bonds, retirement accounts, real estate, life insurance, collectibles, etc. What are your options when it comes to receiving them? Is it a lump sum? Can it be spread out over a specific period? Is it liquid? Can or should it be turned into cash quickly?
Most importantly, you also need to understand the tax implications. Is it taxable? Can the tax liability be spread over many years? Does it get a stepped-up basis? The tax ramifications are not to be taken lightly. You don’t want to make a mistake or try to go it alone regarding taxes.
4. List your goals and priorities
First, what do you want to achieve with your financial windfall? Second, what should you do? It’s called prioritization. They may be different things. You’d like to buy a new car, but if you have little savings or significant debt, or both, you have to move the car purchase down the list.
I recommend turning off all electronic devices. If you’re married, make it a date night. Send the kids to the babysitter. Whatever your situation, get comfortable and clear away distractions so you can focus on what you need to do and want to accomplish.
5. Pay off debt
Yes, this should be one of your priorities, but if it isn’t, here’s a reminder. Pay off any high-interest and non-beneficial debt: credit cards, personal loans, car payments (maybe). Then look at your other debt, home equity loans, student loans, and mortgage. Paying those debts off depends on the interest rate, tax benefit, and the effect on your monthly cash flow.
6. Design a cash flow plan
Also known as the financial windfall preservation plan. If you’re paying off debt, plan to develop healthy spending habits that allow you to hold on to your money rather than blow through it in a matter of years or get into debt again. Understand how your newfound wealth will affect monthly cash flow. Develop long-term financial spending and saving strategies.
7. Create an emergency fund
Everyone should have an emergency fund with three to six months of living expenses available in cash in a savings account. The point is to prevent the need to use credit cards for unexpected expenses and to avoid getting into trouble. If you’ve never had an emergency fund, use this financial windfall as an opportunity to establish one. The importance of an emergency fund should not be disregarded. Learn why an emergency fund is so important here.
8. Gifts and estate planning
Those who receive a financial windfall often want to share it with charities, loved ones, or the less fortunate. There is a proper way to help those that you wish. You may need a gifting strategy to design the most tax-beneficial way to give to those you want to support.
Your team must also address what to do and how to divvy any proceeds when you die. One goal may be not running out of money, so you have something to leave to an heir if you wish. Yes, I know some people instead say the heck with their heirs. They want to spend it all, and you can’t take it with you.
9. Treat yourself
Yep, this comes last. Finally, treat yourself once you have a plan in place and your cash flow, debt, savings, taxes, gifting, and estate planning are complete. It could be a vacation, a new car, a new kitchen, or whatever. As long as you are financially stable, you should celebrate that fact by treating yourself to something special.
Adhering to a planning process for your financial windfall is the prudent path. Taking the emotion out of the situation and replacing it with a plan will reduce the risk and provide financial security to you and your family.
We’ve worked with many people who have received a financial windfall. If you want us to be on your team, call us.