The winner of last week’s Powerball lottery took home a cool $425 million dollars (before taxes of course). While most of us might not expect to win the lottery, it is possible that you may find yourself on the receiving end of a financial windfall at some point in your life. From an inheritance or bonus to the sale proceeds of a home or business, liquidity events have the potential to improve your financial life. However, a lack of proper planning can often result in serious financial blunders. In fact, according to the National Endowment for Financial Education, 70 percent of those who receive a financial windfall will lose nearly all of it within a few years. If you are fortunate enough to receive a surprise sum one day, consider reviewing the following strategies in order to avoid making the same mistakes that so many others do when dealing with sudden wealth.
Pause: Any time you experience a significant life event, it is often a good idea to take a step back and avoid rushing into any major decisions and financial matters are no different. Give yourself a few months to assess the options you may have so you can make the appropriate decision. Do not consider quitting your job or making any major purchases or investments until you have an opportunity to reflect and plan appropriately. Ask yourself, “If I hadn’t received this inheritance, would I actually be purchasing this new convertible?” If the answer is no, take time to assess the entire situation while avoiding compulsive decisions.
Understand what you really have: It is not uncommon for the recipient of a surprise windfall to underestimate the impact of taxes or other fees on their newly found nest egg. Often they plan as though they have more to apply toward their financial goals than is really available. Do you know what the net amount is that you will receive? How significant is the windfall within the context of your goals? For example, If you receive a $15,000 bonus and would like to educate your children, save for retirement and pay down debt, you are going to have to carefully prioritize what is most important. Remember, when it comes to money, it can go just as fast as it can come.
Prioritize your goals and build a financial plan: With so many conflicting financial goals, recipients often struggle to achieve a balance between planning for tomorrow and living for today. Consider creating a list of your short, intermediate and long-term financial goals. Prioritize what is most important to you and your family. Do you need to use the unexpected tax return to pay off high interest debt or are you short on cash reserves? Consider working with a professional to create a financial road map that can highlight the financial impact of various scenarios. Remember, financial windfalls tend to add a layer of complexity to any situation and it is prudent to understand the financial, tax and estate planning implications of any decision. A team approach can help ensure that you have all of your financial bases covered before making any major moves.
Enjoy yourself (within reason): While it may be advisable to focus primarily on the future, consider making “living for today” part of your plan, too. It may be unrealistic to assume that you can direct 100 percent of any windfall to future goals. Instead, consider allowing for some discretionary, fun expenses — but be careful. A professional can help distinguish between appropriate and excessive spending.
Do not become a personal ATM: A sudden increase in wealth can also lead to a sudden increase in demands from others. While it is always commendable to assist those in need, be wary of those simply looking to take advantage. From a child requesting funds for frivolous purchases to a family member looking to borrow money to start a risky business, be careful making rash decisions. Remember to make sure that your core financial goals are addressed prior to taking on the financial needs of others.
A sudden or unexpected windfall can have either a long-lasting or fleeting impact on your financial position. Patience, discipline and careful planning may help ensure that you make the most of any newfound financial resources. Since there are many financial and tax implications when deciding on the optimal approach, consider speaking to your financial, tax and legal advisers to determine the most appropriate approach for you.
Kurt J. Rossi, MBA, is a Certified Financial Planner Practitioner & Wealth Advisor. He can be reached for questions at (732) 280-7550, kurt.rossi@Independentwm.com or www.Independentwm.com. LPL Financial Member FINRA/SIPC.