How to Plan After a Financial Windfall

Almost all of us have had that daydream: what would I do with a big lottery payout? Even if you never buy a lottery ticket, you’ve had that fantasy. Well, you’re probably not going to win the mega-millions jackpot (especially if you don’t buy a ticket), but there is a chance you could receive a financial windfall. It could come through an inheritance, life-insurance payout, large year-end bonus, or a legal settlement.

After you run around the room a few times and let out a few shouts of joy, there are several things you should do; and just as importantly, things you should not do.

The first thing to do is pause.  Don’t do anything rash. Don’t make a big mistake.

Okay, you can treat yourself to a nice dinner celebration or a long weekend getaway (not Las Vegas), and then get to work planning. This initial period of evaluating your options is critical to your long-term success. If handled properly, this windfall can give you greater financial freedom for many years to come, but it is not a guarantee of financial independence, as that requires financial planning.

“When money changes, life changes,” says Susan Bradley, founder of the Sudden Money Institute and author of Sudden Money: Managing a Financial Windfall. “Managing the change is as important as managing the money.”   

It is shockingly easy to squander your newfound fortune.  The non-profit organization, National Endowment for Financial Education, estimates that 70 percent of people who receive a financial windfall have nothing left just a few years later, likely due to lack of financial planning.

The consulting firm Accenture says that between $1 trillion and $3 trillion will be inherited each year for the next 30 years. About half of those inheritances will be for less than $50,000, while about 20% will be for more than $250,000. Many people will use and invest it wisely, but many others will be left wondering: what happened to all my money?

Why You Should Pause Before Spending Your Newfound Wealth

So, let’s consider that pause, which can be hard advice to follow. Experts say it should last from six months to more than two years, depending upon the amount of the windfall and your situation. The reason for this substantial pause is to avoid mistakes and set in motion a positive plan of action. We don’t want to adopt negative or impulsive changes in behavior and financial decision making. Bradley calls this pause period “a decision-free zone” that will allow people to prioritize, plan, and filter out all the noise. Sudden wealth makes it feel like you have free money, and there’s a great temptation to spend it on new cars, homes, gifts, and other things.

You might even be tempted to quit your job the very next day. Don’t. Pause again. The newfound wealth can create lots of tumult in your life; experts say you don’t need to add more of it by stepping out of the workforce too quickly.

So how do you prepare yourself during this pause to make all the necessary decisions?

The single most important thing you can do for your long-term financial success is to hire a Certified Financial Planner™ professional to create a comprehensive financial plan for you, as well as a certified public accountant and potentially an estate planning attorney. The financial plan will provide a clear picture of where you stand financially and help you determine what is realistic in the short- and long- term. The right team of advisors will guide you through the entire process, proving to be a wise long-term investment. 

How A Certified Financial Planner Can Help You

Create a Financial Plan 

All the decisions you need to make and all the goals you wish to pursue can be addressed inside of a comprehensive financial plan. A properly written comprehensive financial plan should include an assessment of the following areas:

  • Personal and financial goals (short- and long- term)
  • Cash management needs
  • Retirement planning goals
  • Estate planning goals
  • Tax planning
  • Charitable giving strategies
  • Protection planning
  • Investment management
  • Intergenerational family wealth planning
  • Education planning

Taking these things into account, along with your tolerance for financial risk, the financial plan provides you with a roadmap to help you achieve and maintain financial independence. Just a few of the common questions that a financial plan can answer include:

  • How should I invest my money so that it grows and lasts for years to come?
  • How much can I spend each year, without the risk of running out of money?
  • How much do I need to save for retirement, and what’s the best way to do that?
  • Should I invest in myself by going back to school to prepare for a new career?
  • How can I gift some of my new money (to family, friends, or a charity)? Read “How Your Charitable Giving Priorities Can Impact Future Generations” for more on this topic.

Plan for Tax Obligations

Depending on where the money comes from, it could be subject to federal or state taxes. Ignoring those tax obligations could come back to bite you later, especially if you’ve spent the money and don’t have the funds to pay the tax collector.

For example, a big bonus or winning the lottery is probably taxable, while some inherited money is not.

Another example is related to retirement accounts. It is increasingly likely these days that an inheritance will include money from an individual retirement account (IRA). If you take that money out, even for a day, and then roll it into your own IRA, you could receive a large tax bill. You could lose as much as a third of the money if you fail to transfer the account directly into an “inherited IRA account.” We discuss this issue briefly in our article “Rules if You Inherit an Inherited IRA.”

It’s complicated. You need professional help on this one. A CFP® or CPA can anticipate your tax obligations and determine the after-tax net value of your newfound wealth. This is also included in a properly written comprehensive financial plan.

Pay Off Debt

The next priority often involves paying off your debts. You’ll almost certainly want to pay off your high-interest credit card balance and student loans, and possibly even your mortgage.

Create an Emergency Fund

Set aside an emergency fund equal to about six months of income or living expenses. It’s a basic piece of financial advice, and now you have no excuse not to do it.  Keep in mind that your lifestyle may change now. The financial plan will help you understand exactly how much it can change, while still fulfilling your financial obligations.

Save for Retirement

Retirement planning is critical to ensuring long-term financial independence. You’ve likely heard the most common piece of advice which is to make the maximum contribution to your 401(k) each year. But sometimes there’s more to it than that. The financial plan will help you understand how much you need to save, and which retirement account(s) are right for you.

Discuss these and other issues with a Certified Financial Planner™ professional.

Remember that financial planning, especially after receiving an inheritance or other financial windfall, is a process. It takes time and effort to gain a perspective on how you feel about your newfound money, your relationships with other people, and what you want for your future.  Bradley warns that relationships can get all messed up.  “Money changes the way we think,” she says. “It’s powerful.”

She and other experts say it’s important that you talk it through, not only with a Certified Financial Planner™ professional and CPA, but with family members and close friends too. It’s also a perfect time to time to review your financial and personal values. Bradley advises that you shouldn’t keep the news to yourself. Discuss your expectations, hopes, and dreams, as well as your value system, with those you trust.

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