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Successfully Managing a Financial Windfall

You’ve heard the stories before: someone receives a tremendous inheritance, or picks the winning lottery numbers, and is sure to live happily ever after, free from financial worries.

However, there’s a catch: that “happily ever after” doesn’t always materialize. In fact, in many cases, sudden money can leave the recipient worse off than before the money came into their life.

This is especially true in the case of lottery winners, who typically aren’t used to such large sums of money, and thus who often mismanage the funds, and can actually diminish the quality of their lifestyle in the process. As it turns out, it’s a variation on the theme of the Prodigal Son. Only the names and the details change.

Of course, the odds of winning life-changing cash in a lottery are incredibly low. Most of us are more likely to be the recipient of an inheritance or an insurance settlement.

Regardless of how sudden money comes into one’s life, it’s the unexpected nature of the event that may create an initial sense of euphoria, as well as a false sense of security. That’s because whether the windfall is large or small, it can seem like “play money,” and that is where the danger may lurk.

“The vast majority of people blow through [a financial windfall or inheritance] quickly,” said Jay Zagorsky, an economist and research scientist at Ohio State University and author of a study on receiving an inheritance.

So, that brings us to the next question. What should you do if you happen to be the beneficiary of a financial windfall?

10 Ways to Protect Your New Money

#1) First, do nothing. This is perhaps the most counter-intuitive advice, but the most crucial. The temptation to buy a new car, take a luxury cruise, or upgrade your living arrangements will be enormous (and may have played a huge part in a lifetime of daydreams). But to make a big purchase upfront is to set a dangerous precedent that can easily kickstart a cascade of unwise, consumption-based purchases that will likely leave the beneficiary feeling regretful.

Instead, wait at least six months before embarking on any life-changing decisions. The time spent waiting and planning allows the “shock” of your newfound wealth to wear off, so you can re-establish a mental and emotional baseline from which to make more sound purchasing decisions.

Moreover, you need to take time to learn exactly what you’ve inherited. Is it all cash? Is it stocks and bonds? Have you just become the owner of a business or real estate? There may be legal and tax-related issues to resolve first.

#2) Talk to a trusted advisor. Find a financial advisor who has your best interests at heart. Unfortunately, as the beneficiary of sudden wealth, this may be even more challenging than it was before the financial windfall.  It is important to select a “fiduciary advisor,” as they are legally required to always put the best interest of their clients ahead of their own.

#3) Doing nothing also means not quitting your day job. It may be tempting to wave goodbye to your boss, but losing the security of steady wages and the lack of social interaction from your work buddies may lead to remorse, even if you don’t especially enjoy your job. Besides, without work, you run the risk of blowing through your money much quicker than you had anticipated. On the other hand, with a good financial plan and the discipline to stick to it, many financial windfalls can benefit someone for their whole life, and perhaps even be used to endow family members or a favorite cause.

#4) Reduce debt. I’ve long been a champion of a holistic approach to financial planning, and debt reduction is a main factor in building true, lasting wealth. Once things have settled down and you have a better understanding of your windfall, it may be time to pay down (or pay off!) high-interest debt. Once eliminated, you no longer have that onerous outflow of interest payments on your loans, so your windfall can remain your wealth, and not someone else’s.

#5) If you don’t have an emergency fund, now is the time to build one.  Set aside reserves of at least three to nine months’ worth of essential living expenses. The future can sometimes throw you an unexpected curve ball — and not all those curve balls will be as pleasant as winning the lottery or receiving an inheritance. Having cash reserves set aside will reduce your financial stress so you can sleep better at night knowing you are prepared to cover true emergencies down the road.

#6) Additionally, you may decide to allocate additional funds toward savings and retirementAgain, each financial advisory client is unique, with various goals, personal circumstances, and financial resources. What our team recommends for one person may vary significantly from what’s best for another. Where you are in your path to building true wealth will determine next steps, which is why having a financial advisor you can trust is vital.

#7) Think about tax and estate planning. No one is sure what may or may not happen to the tax code this year or next, but it’s critical that you get a solid handle on the tax ramifications of your inheritance in order to maximize your financial benefit.

For example: did you know that you may be required to take distributions if you inherit an IRA? What if you are already taking required mandatory distributions? Things can get tricky even in situations of good fortune, but sound advice can quickly ease any concerns.

Additionally, life changes are a great time to update your estate plan, especially if the inheritance increases the complexity of your financial situation. With a sudden windfall, you become a target for everyone (from distant acquaintances to immediate family members) who now see you as a great source of funds for their own purposes. Protect yourself and the ones you love with proper estate planning.

#8) Be cautious. Less-than-reputable salespeople and relatives may suddenly warm up to you, with the unspoken goal of separating you from your cash. That’s why a trusted advisor is critical. If you have a well-thought-out financial plan, it’s much easier to pass on potentially exploitative offers. Besides, it’s much easier to let someone down by saying “I’d love to help you out, but my financial advisor says no.” Pass the blame onto your advisor, which can help you keep both your friends and your money.

#9) Consider gifting. Do you have a favorite charity? Would you like to help a niece or nephew finance their education? Now is the opportunity to explore the possibility of helping others.

#10) Have some fun. There’s nothing wrong with treating yourself. As we provide counsel, we would like to leave some room for self-indulgence.

Do you like to travel? Have you thought about an addition to your home, finishing your basement, remodeling your kitchen, or upgrading appliances? Maybe it’s those top-of-the-line golf clubs you’ve been eying, or a new car. Or, maybe you’d like to invest some time and money into catching up on the everyday things of life that you’ve been putting off. Everyone has a “hot button” or a “bucket list.”

Perhaps more than anything else, a financial windfall gives you the flexibility to do a great many things ranging from pursuing your lifelong dreams to improving the lives of those around you.  Working with a well-trained and trustworthy financial advisor, and having a financial plan in place, can allow you to maximize the all of the benefits of your financial good fortune.     

Learn more about the author, Barton Couch, CFP®.