Here's How to Handle an Unexpected Financial Windfall
Receiving an unexpected financial windfall can be a life-altering event. Whether an inheritance, lottery winnings, legal settlement, sale of a business, or a substantial bonus from your employer, such a spike in your cash flow can be just as overwhelming as it is exciting. Though it may not seem like much of a problem to come into a lot of money all at once, it certainly requires a plan to make sure that it not only lasts but also helps to enhance your overall quality of life.
Sudden wealth has the power to transform the lives of those who receive it, with outcomes ranging from positive to negative or somewhere in between. This potential transformation is due to the number of decisions that come along with receiving a large sum of money. Each decision carries the possibility to either squander the funds or use them productively, enhance overall happiness or diminish it, and strengthen personal relationships or undermine them.
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The initial shock of receiving a financial windfall can be an ordeal of its own. Although it can be tempting to quit your job, make large purchases, or announce your good fortune to the world, it is important that you avoid making any immediate decisions. It is crucial to give yourself time to process the news and allow the initial excitement to fade.
While you’re contemplating next steps—and prior to taking any action—consider what your newfound riches could help you achieve. And while it will certainly be necessary to tackle the inevitable financial tasks that go along with coming into new money, it is equally as important to consider how this money might be used to improve your overall quality of life.
It can also be helpful to choose a confidant qualified to act as a voice of reason to keep your mind at ease as you mull over your big ideas. Whether this person is a relative, close friend, or mental health professional, you will want to be sure they are capable of taking on this role for you and willing to speak candidly as you discuss sensitive financial matters.
Once the rational side of your brain has regained control, assess your current financial situation, including any outstanding debts. If you are carrying any unproductive debts that are not tied to an asset, such as high interest credit card balances or personal loans, it is generally a good idea to eliminate those immediately.
However, if you are holding any productive debts that either allow you to earn a living or are secured by a physical asset—such as an auto-, mortgage, or student loans—determining when to pay them off may not be so straightforward. Some say freedom from debt is the most important goal, but most people want to balance planning for the future while tackling present day financial concerns.
If you are like most people, you will need to manage your finances for both present and future needs. This is where it can be helpful to prioritize your financial goals, ranking them from most to least important. Additionally, identifying the tasks with the highest priority against those that can be delayed will further assist you in determining how to allocate your windfall effectively.
For instance, a goal of building an emergency fund capable of covering three-to-six months' worth of living expenses in preparation of unexpected events (e.g., job loss, medical emergencies, or urgent home repairs) should take precedence over a personal goal to pay off a student loan. However, a person who has already amassed substantial emergency reserves should feel free to focus on eliminating debt or investing for the future.
Receiving a financial windfall is also sure to have an impact on your tax situation. It is important that you work with a tax professional to understand the tax consequences of your good fortune and to develop strategies to minimize your tax liability.
If possible, you want to have this conversation prior to receiving any funds, as there could be options available to alter the method you receive the money that would reduce your tax liability. For instance, if you are receiving a large sum from the sale of a business or property, certain tax strategies—such as installment sales or like-kind exchanges—could defer or reduce taxes. Understanding and applying these strategies beforehand helps to ensure you keep more of your money in the long run.
If you are inclined to share your newfound riches with family, friends, or charitable organizations, do so thoughtfully. Consider the impact of your gifts on your own finances just as much as the recipient’s. Establishing clear boundaries and priorities will help ensure that your philanthropy aligns with your long-term financial goals and values. It will also help make sure that hasty or overly generous donations don’t deplete your savings just as quickly as you received them.
Determining the best path forward after receiving an unexpected windfall doesn’t have to be a frightening task. However, it does require thoughtful planning and decision-making to ensure that this newfound wealth aligns with your life goals and values. By taking a methodical approach, defining your priorities, and seeking assistance from others where needed, you can turn this once-in-a-lifetime opportunity into a lasting legacy.
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Malcolm Ethridge, CFP® is the Managing Partner of Capital Area Planning Group based in Washington, DC. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
NOT FDIC-INSURED | NOT BANK-GUARANTEED | MAY LOSE VALUE