An astounding 70% of inter-generational wealth transfers fail by the time they make it to the second generation. According to a landmark 20-year study by Williams Group founder Roy O. Williams, the losses that took place were based on an overwhelming lack of identification of shared financial values passed down to heirs through long-term lessons. Clearly, communication of values, financial lessons and expectations is the key.
So, what do you do if you find yourself with a financial windfall? Whether it be an inheritance or a big win, the steps are relatively similar. The most important thing you can do is seek out a professional advisor to help you determine the best way to manage your windfall. (For more, see: 3 Ways to Manage Lump-Sum Windfalls.)
Take Your Time and Plan
- Take time to make plans for your great fortune. Seek out the advice of a trusted advisor before you make any final decisions about spending, saving, investing or paying off debt, because the implications of each are many.
- Carefully weigh any strings attached to the windfall, as there may be limits upon the money or items you receive.
- You may even have to adjust your current financial plans, since they were likely built on the resources you had prior to receiving the windfall.
- Don’t assume you can’t possibly spend that much money. It’s much easier than you might think, especially when making a well-deserved splurge on a big-ticket item.
- Watch out for a line to form that consists of hard-luck stories and business partnership schemes from family and friends. Make sure you get your investment advisor’s help before making any investment decisions. Plus, for the sake of relationships, you’ll have someone to blame if you need to say “no.”
Factor in Tax Consequences
A financial windfall is an exciting time. A factor which may diminish that excitement is the tax consequences of such a windfall. During this time, it is more important than ever for you to have a financial advisor and income tax advisor willing to work together for your best interest. Here are some things to consider:
- For an inheritance, what type of property is being inherited? Is it cash? Is it property with a stepped-up basis, such as stocks? Is it “income in respect of decedent” property, such as an IRA? Is it property with ongoing expenses, such as real estate? Each of these has its own income tax consequences.
- For a lottery winner, do you take a 20-year payout or a lump sum payment? What is the projected income tax cost associated with each? What’s more, once the income tax issues have been addressed, the advisors need to continue to work together to achieve the best after-tax return on the investment of the windfall. (For more, see: Five Tax Strategies for a Bonus Or Windfall.)
Consider Your Stage of Life
There are so many possibilities for a windfall. With the help of your trusted advisor, they can help you work through your situation based upon the stage of life that you are currently in. Here are a few age-related considerations to keep in mind:
- It maybe cheaper to accelerate repayments of some debt such as credit cards and student loans, if the cost of carrying that debt is much higher than current interest rates.
- If you don’t already have one, you should open a retirement savings account for any funds to be transferred to you if your employer does not offer a company-sponsored plan.
- Consider establishing homeownership. Keep in mind that the typical down payment is 20% of the home’s selling price. You’ll also need to consider insurance, taxes and maintenance.
- If you have children, now would be a great time to consider 529 plans, Coverdell and other tax-favored educational savings options.
- Assess your insurance levels and plan for additional insurance that fills any gaps you identify.
- Expanding your investing at this stage is important. At this stage, 401(k) investments, IRAs, health savings accounts or annuities may be an option. Your advisor can help you diversify your portfolio and look at your investment options.
- Now is the time to ensure you and your financial professional have drafted a solid plan that takes your preferred level of risk into consideration. A windfall may require some adjustments to that plan and your advisor can help you adjust your asset allocation.
- If you don’t already have one, you should discuss an irrevocable trust with your advisor as an option that helps you pass assets on to your own beneficiaries after your death, without the difficulties and expense of state probate.
- Determine ways to accelerate your savings, especially since many catch-up contribution options open for you at this age.
- Your windfall may enable you to purchase additional insurance. Have a discussion about long-term care with your advisor, especially since purchasing options may decrease as you age.
Your 60s and Beyond
- A windfall at this age means you may need to adjust any distributions you are taking.
- Your advisor can help you strategize your Social Security benefits, distributions and review your insurance and Medicare coverage.
- They can also help you identify any necessary adjustments to your estate plan.
Your advisor can help you work through a variety of scenarios that take into consideration your acceptable level of risk in achieving your goals. Depending upon your situation there are other strategies that you might consider applying a portion of your windfall to.
- Paying down debt may be a good option for you at any age, but there are considerations that an advisor can help you with, such as determining the benefit of paying off a mortgage weighed against the tax benefit of that mortgage.
- Your advisor can help you with options like fixed annuities which may be good for those who need a set income in retirement.
- Charitable giving may be an option to pursue. In some cases, a deduction may offset the tax on payouts, interest and dividends. But be sure to have your professional advisor check the charity out to ensure they limit how much they spend on executive salaries and fundraisers.
Seek Professional Help
With an inheritance there is often an emotional attachment to the windfall, but that doesn’t mean you should force yourself to invest like your Aunt Dorothy did. Conversely, with big wins like that from the lottery, there is less of an emotional attachment. Either way, careful planning should be made. An advisor that understands cognitive biases can help you work through the irrational thoughts that sometimes come with a windfall.
The study mentioned above also suggests that those families who worked with professional advisors fared better than those who did not. The key to handling a financial windfall is to take steps to ensure that you or your heirs don’t become part of the 70% statistic. With careful communication and financial planning, you can help ensure you make the most of your great fortune. (For more from this author, see: 6 Cognitive Biases That Can Derail Your Portfolio.)
Disclaimer: Kris Maksimovich is a financial advisor located at Global Wealth Advisors 18170 Dallas Parkway, Suite 103, Dallas, TX 75287. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (972) 931-3818 or at email@example.com.