A financial windfall is the stuff of dreams. But it can also bring unexpected complexities.
Receiving a large sum of money, such as from an inheritance, equity compensation, or business sale, can open up enormous opportunities for your family, your career, and the impact you can make in your community. It can also trigger what’s known as "sudden wealth syndrome," a term used to describe the stress, anxiety, and questions around identity that can arise as you adjust to your new circumstances.
Much of that stress is a result of a more complicated financial picture. You may be rethinking your retirement date, or even your entire career. You may feel a desire (or pressure) to offer financial support to family or friends. And you may feel overwhelmed by the need to navigate complex new tax, investment, and estate-planning considerations.
Given that, one of your first steps should be to establish a team of financial professionals, which might include a financial advisor,1 estate and tax planning attorneys, and an insurance specialist. “A financial windfall can be life changing, but turning it into a source of lasting security and long-term opportunity requires thoughtful planning,” says David Peterson, head of advanced wealth solutions and Fidelity Personal Trust Company at Fidelity Investments.
Here are 5 questions to work through with your advisory team as you assess your next steps.
Q1. What is my new net worth?
Depending on the source of your new wealth, its value on paper and the amount of money you can actually access may be very different. In the case of an inheritance that is passing through probate, for example, you may not receive the assets for many months, even a year or more.
It’s also important to consider the potential impact of taxes. If you’ve sold a business or inherited certain types of assets such as a retirement account, your windfall may be subject to federal and state income or capital gains taxes.
For equity-based compensation, the type of shares you receive can make a significant difference. For example, if you have restricted stock units (RSUs) you will generally have taxable income when they vest, then another taxable event if you hold on to the shares and ultimately sell them. In contrast, if you have non-qualified stock options (NSOs), there is no regular income tax due at grant or vesting. NSOs are taxed at exercise and included in your compensation income; subsequent sales of the shares acquired are then treated as capital gains or losses as applicable. Incentive stock options (ISOs) may result in different tax treatment.
If your windfall is in the form of taxable income, talk to an advisor about strategies that can potentially help manage your income tax burden, such as timing charitable contributions to maximize available deductions and donating appreciated securities that have been held for the long term.
Q2. How much can I spend?
Before making major purchases or life decisions, take time to understand how they could affect your longer-term financial picture. But that doesn’t have to mean putting everything on hold. “Maybe you want a new car or a vacation,” says Peterson. “It’s okay to reward yourself.”
That said, it’s important to avoid lifestyle creep, where your spending rises to match your new net worth, turning former luxuries into perceived necessities. An advisor can run the numbers on how much you can realistically afford to spend right away and help you evaluate the tradeoffs involved in major financial commitments.
You’ll also want to work on identifying and funding longer-term objectives. For example, you might want to implement strategies that can help generate a fixed income stream, which can allow you to make a generous upgrade to your lifestyle or scale back at work. Or you might want to invest some of it in a new business or piece of real estate.
“An advisor with experience in financial planning and working with clients who have had similar windfalls can be a valuable sounding board as you think through the various decisions and how this newfound wealth can help you accomplish your goals,” says Peterson.
Q3. How might I want to adjust my investment portfolio?
A sudden influx of wealth can create imbalances in a diversified portfolio, whether that looks like a large concentration of cash, real estate, or shares of a single stock. If you have inherited multiple accounts or assets that are spread across different firms, you may want to start by consolidating everything at a single institution to help ensure you can easily track what you now possess.
If some or all of your windfall comes in the form of equity, one of the first decisions is how many shares to keep and how many to sell. Left unaddressed, a large position in a single stock can expose you to concentration risk, where a significant portion of your wealth depends on the performance of one company.
A financial advisor can help you develop a strategy to manage portfolio concentration that balances liquidity needs, tax considerations, single-stock exposure, and any desire to retain some ownership to participate in your company’s growth potential.
If you have new assets to invest, you may want to take advantage of the broader range of investment opportunities that can become available as your wealth grows, such as real estate, private markets, and other alternative investments. An advisor can help identify options that align with your financial qualifications, long-term goals, and asset allocation.
Q4. Am I exposed to any new risks?
As your wealth grows, it may be worth reassessing the risks that come with increased assets, visibility, and financial complexity. “Substantial wealth can expose you to more liability and, in some cases, can make you a target for those looking to take advantage of others,” says Peterson. Be aware of your personal, home, and cybersecurity practices, particularly if you now own significant assets or have become more visible in your community or profession.
It’s important to revisit your property, auto, and specialty insurance policies to confirm they reflect your current assets and circumstances as well as any new purchases. You may also need to consider excess liability (umbrella) coverage.
It’s also a good idea to have an insurance professional review your life insurance coverage. While life insurance is often purchased to replace lost income, as your wealth grows it may play a larger role in your estate plan, helping you efficiently transfer assets and achieve your legacy goals.
Q5. Does my estate plan reflect my wealth transfer goals?
After a significant increase in wealth, family members or friends may turn to you for financial assistance. “This is the time to think through who you want to be and what this money means to you,” says Peterson. Expectations around giving have the potential to cause emotional rifts, so before making a gift, consider who you want to support, how much you want to give, and what expectations, if any, may come with that support.
An advisor can help you determine how much you can comfortably afford to give and how to evaluate the potential impact on your long-term plans. “From a planning perspective, gifts to family members or other loved ones may help reduce future estate tax liability, while charitable giving can provide both income and estate tax benefits,” adds Peterson.
Have an estate planning attorney take a fresh look at your estate plan to help ensure you have accounted for your new assets and how you want them to be transferred to your beneficiaries. You may also want to discuss whether a trust could potentially help with safeguarding assets, preserving privacy, supporting philanthropic objectives, and reducing potential future estate tax liability.
A key relationship
A windfall can potentially alter your financial picture, warranting a review of your overall strategy. Having an advisory team can help you make thoughtful decisions during a period of transition and help build a framework for managing and preserving wealth over time.
“Taking a reflective and conversational approach to planning can help you feel confident that your financial plan will help you achieve what matters most to you,” says Peterson. “You can and deserve to have fun with this—while doing it as part of a sustainable wealth-building process.”