Congratulations! You have just received a large windfall of money. Now what? The best thing to do right now may be nothing—at least, don’t do anything rash.
Of course, you may want to celebrate. Treating yourself and your family to something special is a perfectly healthy and natural urge. But wait. Take your time. And consult experts and your family so that you can make the best decisions, ones that will stand the test of time.
Think about these steps that may help you if you receive a substantial inheritance or life insurance proceeds, sell a business, or win a large lawsuit or the lottery.
Take your time.
Take your time and be thoughtful about how you want to spend or invest the money. First, talk with experts and family members, and make sure you are clear about what your priorities are for the money, whether it is paying off a mortgage, paying for a family member’s education, increasing your charitable giving, or something else. It can be detrimental to your long-term financial planning if you let your irrational exuberance get the better of you.
Park your money.
Give yourself time before making a major decision on what to do with a large windfall. For now, consider keeping the money safe and secure. For most people it is far better to lose some potential return in a low-interest account than to take major risks or make financial moves that haven’t been fully thought out in terms of tax considerations or your entire financial picture.
Consider working with a team of professionals.
A windfall can radically change your financial situation. For example, it could place you in a different tax bracket, cause you to rethink your estate plan, or change your investment objectives. Consider consulting an estate planning attorney, a certified public accountant, and/or a financial adviser. In addition to financial planning, you’ll likely want advice on how to handle the income and estate tax implications of your windfall.
It's a good idea to keep your job.
Many people are tempted to quit their job when they win the lottery or receive a windfall of any kind. But quitting your job may be the worst thing you can do. What if taxes are taken out of the funds, leaving you with less than you anticipated? In addition to the obvious loss of wages, you might miss the social and professional interaction, as well as the many workplace benefits, such as tax-advantaged retirement accounts, health insurance, high-deductible health plans that offer Health Savings Accounts, or executive compensation.
Review your estate plan.
One estate planning rule of thumb is to review your plan every three to five years or whenever a major life event occurs, such as a family birth, marriage, divorce, or death. A major windfall also qualifies as such a life event, and is a great reason to review and update your estate plan. This is especially true if it significantly changes the size and complexity of your estate.
Be aware of the impact of taxes.
It’s critically important to know the net after-tax value of your windfall, and that you will need sufficient liquidity to pay those taxes. To analyze this, you’ll need to take into account income, gift, and estate taxes, on both the federal and state levels.
“Let’s say you receive life insurance proceeds. These and some other windfalls might not be subject to federal income taxes,” says Ajay Sarkaria, senior wealth planning specialist at Fidelity. “But those who receive other types of windfalls, such as a lottery winning, might also have to pay state taxes out of those proceeds.” But every situation is unique, so you should consult a tax adviser about your personal circumstances.
Sit down with your family.
This is an excellent time to gather your family together and revisit your overall financial situation, goals, and values. “There’s certainly an emotional side to the windfall that’s often overlooked,” says Andrew Hamil, national manager of Fidelity’s trust and estate consulting group. “Money can change people, and you want to get ahead of that if you can.” You should also consider inviting attorneys, accountants, and financial representatives to the conversation, if appropriate.
“Let’s say you inherit a business,” says Sarkaria. “You might be one of several family members acquiring a portion of it. If so, you’ll need to sit down and figure out what you want to do with this business or family entity that has been passed down.”
Some things to take into consideration include 1) Who’s going to manage the finances on a day-to-day basis? 2) If you plan on selling a business or a portion of the business, what restrictions are there on selling your share?
Tip: Read Viewpoints: "Get started now on business succession planning."
If you don’t need it, you may want to disclaim it.
Some people might receive a windfall, but not really need it. In that case, they could “disclaim” it, which would allow the assets to bypass them and go directly to their heirs without being subject to estate taxes. For this and other reasons, it’s important to have an estate plan in place.
“A disclaimer is a qualified refusal of an inheritance,” Sarkaria explains. “It needs to be done in an affirmative manner. You have to not accept or enjoy the benefit of any of the assets that you would otherwise inherit.
Not all windfalls are a good thing, and if it’s going to have a negative impact, you might want to discuss it first with your family. It may make sense to disclaim, or refuse, all or a portion of that inherited windfall.”
Sarkaria suggests working with a professional adviser if you decide to disclaim an inheritance.
Consider all the possibilities
As you weigh the options for what to do with your windfall, here are some action steps to consider:
- Pay off high-interest debt. Generally, whenever you have debt that comes with a high interest rate, such as a credit card balance, you should try to pay it off as soon as you can.
- Create an emergency fund. If you don’t have one already, now’s a great time to build one. It should be enough to cover at least three to six months of your living expenses.
- Revisit your investment plan. Your windfall may mean changes to your investment goals or risk tolerance. Now is a good time to sit down with a financial adviser and make needed adjustments.
- Invest in yourself. You could use some of the money to do something special that you couldn’t otherwise afford. For example, you could go back to school to learn new skills, open the business you’ve been dreaming of, or take a break from work to finish that great novel you’ve always wanted to write.
- Splurge a bit. Once you’ve made the big decisions on what to do with the bulk of your funds, consider treating yourself. Maybe you want a new car or a boat, or a special vacation with your spouse or the whole family.
- Give to charity. You may wish to donate some of your newfound money to charity, because of either potential tax implications or your increased ability to make a difference, or both. Depending on the size of your donation, you might simply write a check, donate appreciated assets, or consider a more formal arrangement.
- If you don’t need it, disclaim it. If you don’t really need the windfall, consider disclaiming it, which would allow the assets to bypass you and go directly to your heirs, without being subject to estate taxes.
When trying to decide among competing priorities, work with your tax adviser or financial planner to determine what makes the most sense given the various advantages and trade-offs.
Whatever you do, don’t rush, unless, of course, there is an urgent need to use the money now. Enjoy the freedom that the windfall provides and give yourself the additional gift of time. Taking a deliberate approach will allow you to enjoy the process and make more thoughtful decisions that you will be happy with for a long time.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917