We’ve all heard the stories of lotto winners who win millions, think they’re set for life, and then go broke within a decade. Or people who inherit large sums of money and end up in financial ruin, family feuds, or both. The word “windfall” can mean different things to different people — if you’re young and drowning in debt, even $10,000 can do wonders for your quality of life. If you’re older with no debt and decent retirement savings, it will probably take a lot more to really change your life. Whatever the amount is, here are 12 things you should consider if you receive a large financial windfall.
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When you first receive the news, keep it to yourself for at least a few days. Tell your spouse, but that’s it. Don’t quit your job, don’t shout from the rooftops, don’t give $1,000 to everybody you know. Just take a deep breath and think about how you might want to use the money. This is especially key if your windfall is the result of an inheritance or life insurance policy — take the time to grieve your loved one, and put the money in a savings account until you can deal with it with a clear head.
If word of your windfall gets out, “financial experts” will turn up out of nowhere. Ditto for friends, acquaintances, or even perfect strangers just dying for investors in their new business. Say no to everything the first time around. If any of the offers to help are legitimate, the person will keep trying. And if any of the business ideas were that good, they probably would have been done already. Don’t part with any of your money until you have a chance to evaluate your options.
Depending on where the windfall came from, it may be taxable. Lottery, (legal) gambling, or other prize winnings are taxed as ordinary income. Life insurance proceeds are generally not taxable, while other inheritances may be subject to income and/or estate tax. If necessary, hire a tax advisor to help determine how much tax you will owe. Set aside that amount immediately so that you have it when the time comes to pay.
If there’s a charitable cause you really believe in, it would be great to donate a portion of your windfall to that cause. You might even want to donate to your church. If you truly want to and can help individual family members or friends, do so. But beware that helping one might mean others asking for handouts. Limit your assistance to those who truly need it and can keep it to themselves. And don’t feel the need to give more than a small portion of your money away, unless you really want to and are otherwise in a position to do so. Your own needs and those of your immediate family must come first!
When you receive a financial windfall, it’s ok to use a small portion for fun (say, no more than 10%, though it depends on the total amount). Take a nice vacation. Treat your wife to the spa day she’s been asking for, or yourself to some new golf clubs. If we’re looking at a windfall of $5,000 and you’re a grad student on a shoestring budget, this might just mean treating yourself and a date to dinner and a movie! Whatever your mini-splurge is, plan for it, and make it a one-time deal. No fancy steak dinners every other night, with lobster on the nights in between!
If you don’t yet have at least six months of expenses saved, put at least that much aside now in a high-interest savings account, short-term CD ladder, or money market fund.
Depending on how old you are, and unless we are talking about a really hefty sum of money, it is doubtful that your windfall can replace your income for the rest of your life. Don’t quit your job or substantially increase your standard of living unless you are really certain that the money will last. In order to be really certain, it’s probably best to hire a professional to run the numbers, which brings us to the next tip.
At some point after you received your windfall, it is probably a good idea to get a professional involved to help you evaluate your options for future, spending, savings and investments. If you have a financial planner already, ask him if he is comfortable advising you on such a large sum of money, and if he can provide references from current or former clients.
If not, ask for a referral to another planner. You want a financial planner who specializes in lump-sum management or high net worth clients. If you don’t have a current advisor and you’re not sure where to start, discreetly ask a trusted (financially comfortable) friend or colleague for a referral. You can also turn to the Garrett Planning Network for a list of fee-only advisors in your area.
When dealing with a large sum of money I would definitely recommend a planner with an hourly rate rather than one that charges a percentage of your assets or a commission on investments. Your financial planner will help you create a plan for the rest of your money — I discuss some possible options in the final four tips below.
Pay off as much debt as you can, including credit cards, student loans, auto loans, and even your mortgage if you can afford it. Especially if your windfall comes from a life insurance policy on your spouse, make sure that you set aside enough to cover all the expenses that your spouse would have paid for, such as mortgage, tuition, childcare, etc.
Additionally, make a commitment to stay out of debt — if you can truly afford to buy a fancy new car IN CASH with your newfound wealth, that’s one thing. Financing your dream car because you have a lot of money to pay it off with “later” is quite another.
If you were already saving for multiple short-term goals such as a new house, a large vacation, a wedding, car, or continuing education, you may want to fund some or all of those goals with your windfall. A financial planner can help determine what you can afford and on what schedule.
If you have longer-term goals like early retirement, paying for school for your kids or grandkids, making large charitable contributions, or moving to a different state or country, begin planning for the payment of those items now. A professional can help you determine a time horizon and appropriate saving/investing strategy for each one.
When all your goals are planned for, and the rest is truly yours to spend as you wish, consider investing the remainder conservatively (say in a bond fund or treasury bills) and living off the income. Once you reach retirement, you can begin drawing down the principle as needed. This strategy will help you make the money last over your life expectancy, and maybe even leave some as a windfall for your own beneficiaries.
The bottom line is that you should be as careful with this newfound “free” money as you would with money you worked hard to earn. Used correctly, a windfall can push you dramatically forward on your path to financial freedom. But if you get caught up in buying lots of things or helping too many people, you could end up worse off than before. Regardless of the specific course you take, remember to make well-thought-out decisions and involve your immediate family and a professional where appropriate.