CFP

Special Circumstances - Monetary windfalls


Monetary windfalls can come in a number of forms. Under any scenario, the recipient needs to take some time to reflect on what they would like to do with their newfound wealth and avoid the temptation to make quick decisions they may regret later.

Types of windfalls

  • Personal injury settlements
    • Taxation - A lump-sum payment from a personal injury usually is tax free, but income and gains on invested portion of the lump sum are subject to taxation. Punitive damages are taxable.
    • Structured settlement - A payment for personal injury under which all or part of the payment is made in future periodic installments. The defendant may buy an annuity from an insurance company to ensure the periodic payments are made as promised. Structured settlement payments are tax free to the recipient.
  • Other types of settlements - Include workers' compensation and employment discrimination.
  • Inheritances
  • Gifts
  • Lottery winnings - Subject to federal taxation as ordinary income. Usually subject to state taxation also.
    • Annuity payout - Large lottery jackpots usually are paid out over a number of years rather than received as lump sum.
    • Sale of annuity payments - A lottery winner wanting or needing lump-sum payment may sell the annuitized award to a company in return for a large, upfront payment. The lump-sum payment received usually is significantly less than the present value of the annuitized lottery payments.
  • Life insurance proceeds
    • Death benefits - May be received either as lump sum or annuity. Death benefits received tax free.
    • Pre-death benefits - Surrender of a policy or withdrawal of all or part of the cash value subject to taxation to extent cash received exceeds the owner's basis in the form of total premiums paid.
    • Life settlement - The sale of a life insurance policy by the owner to a third party in exchange for a lump sum that typically is greater than the policy's cash value but less than the policy's face value. Distinct from a viatical settlement paid to a terminally ill person.
  • Retirement lump sums

Issues to consider
Receipt of a large sum of money for an individual of modest means creates significant planning issues for the recipient and his or her advisors.

  • Planning - There is no need to rush into any decisions about what to do with the money. The best course of action is to step back and carefully assess the situation. Seek trustworthy, outside assistance.
  • Emotional issues - Exuberance, guilt, suspicion.
  • Goals - Consider long-term financial and lifestyle goals in light of new financial condition.
  • Risk tolerance - Assess tolerance for risk in investing new assets.



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