How to Manage Sudden Wealth
You got a financial windfall. Now what?
You came into possession of money you did not expect. Now what?
A windfall refers to a significant financial gain that is often unexpected. Potential windfall sources include inheritances, lottery wins, and lawsuit settlements.
This amount could range from thousands to millions. Windfalls could suddenly pay bills but also bring sudden challenges, such as investment planning and jealousy.
Read more to learn how a professional could help you maximize your windfall and enhance your standard of living.
This article is not legal, financial, or tax advice.
Understand any Special Considerations
Worry might eventually replace your excitement due to the responsibilities attached to newly acquired wealth, including:
- Paying taxes
- Updating estate plans
- Establishing a budget
- Protecting assets
These responsibilities depend on the windfall's source and applicable law.
For instance, did you receive a life insurance payout or an inheritance? Are you familiar with the tax consequences for each?
There are specific circumstances where special tax rules apply, such as Individual Retirement Arrangements and assets that appreciated since the departed acquired them.
Similarly, while the IRS takes a percentage of lottery winnings, states and local governments could withhold even more. You need to understand how much you are legally required to pay in taxes on a Federal, State, and local level.
Apart from tax collectors, you may need to protect your windfall from a future spouse via a prenuptial agreement. Divorce is common and a prenuptial agreement can protect your premarital assets.
If you are currently married and received an inheritance, you should immediately consult with an estate planning attorney to determine if you can keep your inheritance as your separate property.
Review Your Assets
Blood work is not the only regular checkup you should be doing. Routinely checking your financial health could help you identify how prepared you are for sudden events and how on track you are to achieving financial goals.
Before embarking on whatever journey your windfall could take you on, it is essential to know where you are today.
There are several ways to review your existing assets and expenditures, such as calculating your net worth.
You can calculate your net worth by subtracting your liabilities, such as credit card loans, from your assets.
Someone with robust financial health may have a high credit score, an emergency fund, and a detailed budget.
Wealth management is rarely a straightforward process.
It could be beneficial to consult a professional to prevent a mistake that could compromise your livelihood.
Financial advisors, attorneys, and certified public accountants could safeguard your financial portfolio and simplify complex financial issues.
Additionally, a professional could provide objective advice about your money.
People that experience a windfall sometimes experience guilt over their newfound wealth and severe anxiety about losing their money.
In emotionally charged cases, a professional could strategize without being under the influence of vengeance, pain, or sorrow.
A financial advisor registered with the U.S. Securities and Exchange Commission has a fiduciary duty to act in your best interest and could maximize your investment funds.
Similarly, an accountant could ensure compliance with state law and prompt filing of required documents.
Create a Comprehensive Plan
Consumers with a plan are almost twice more likely to pay their bills punctually and save monthly than those without one.
Financial planning requires accurate calculations and legal considerations.
You could skip trying to figure out the difference between a portfolio and a prospectus by consulting with a financial planner.
A financial planner could also expose any imbalance of economic power between an "in-spouse" and an "out-spouse."
An in-spouse possesses all economic knowledge and power in the relationship and either consensually or forcefully keeps the out-spouse in the dark about joint finances.
This dynamic makes out-spouses vulnerable to financial abuse.
All spouses, but especially out-spouses, could benefit from a comprehensive financial plan for spending, saving, and investing.
An optimal financial plan includes:
- Short, medium, and long-term financial goals
- Debt management
- Net worth statement
- Emergency expenses
- Cash flow budgeting
- Retirement savings
- Insurance costs
- Estate planning
Pay Off Your Debts
In most cases, paying off high-interest debt is the most effective way to save money.
The average American is $51,900 in debt.
Additionally, over 3.3 million Americans have overdue child support debt.
Debt blocks financial security by lowering someone's credit score and impeding cash flow.
We are all susceptible to sudden illness, injury, and family costs.
Consider your windfall an opportunity to prepare for unforeseen crises by breaking out of debt.
Create an Emergency Fund
Allen Iverson earned approximately $200 million between 1996 and 2011 as an NBA player. By 2012, he depleted his fortune through reckless spending and could not afford his debts.
Iverson exemplifies that even the most significant windfalls could drain relatively quickly without financial literacy and management.
He could have benefitted by replacing the garbage bags of money he allegedly kept around his mansion with an emergency fund.
An emergency fund refers to savings or a bank account put aside for unanticipated crises.
The ongoing pandemic reminds us of how unpredictable life is. An emergency fund could help you weather the storm of unexpected medical costs or unemployment by keeping you financially afloat.
Your emergency fund's amount depends on several factors, such as your cash flow, job security, and debts.
Generally, you should set aside three to six months' worth of expenses.
You can gradually grow your emergency fund by allocating a small portion monthly.
A windfall could fully cover your emergency fund.
The faster you establish your emergency fund, the sooner you will be prepared for an unplanned difficulty.
Put Some Aside for Retirement
Nearly 50% of Americans report that they are struggling or will struggle with their retirement finances.
A lack of retirement security may require you to work longer, rely financially on loved ones, or depend on public assistance to survive.
One way to increase the likelihood of financial independence during your golden years is to start saving for retirement as early as possible.
A windfall could jump-start or optimize your retirement savings.
There are many benefits to setting up a retirement fund immediately.
Some employers match their employees' contributions to a 401(k) account. For example, if an employee contributes two percent of their gross income each pay period, the employer will put the same quantity in their retirement fund.
The faster an employee starts contributing, the more money their employer will essentially give away to them over the years.
The employee will also owe less money in taxes. For instance, an employee that earns $50,000 but contributed $2,000 to a retirement fund will only owe taxes on $48,000.
Additionally, money in retirement funds compounds over time. Depending on your account's return rate and your contributions, you could retire with a significant sum of money without having to work directly for it.
Mark Twain's legacy of literary excellence and civil rights advocacy lives on.
Twain amassed a fortune as one of the 19th century's highest-paid authors. In 1894, however, he declared bankruptcy after a series of bad investments.
You could follow in Twain's footsteps by investing your windfall in mostly inventions and technology, or you could explore a variety of investment options, including:
- Mutual funds
- Exchange-traded funds
- Index funds
- Stock options
- Real estate
It's best to consult with a professional, such as a certified financial planner or chartered financial analyst, to avoid any of Twain's financial mistakes and maximize your returns.
A professional could help you identify investment goals, automate your investing process to the maximum extent possible, and manage investment fees to maintain your costs low.
Additionally, they could explain the long-term value of investing, such as fewer trading fees, compound interest returns, and effectively coping with market volatility.
We hope you enjoyed this article.