How to Handle a Financial Windfall

Derek Ferriera and Martin Johnson
Posted: 7/27/2010

It may sound like a challenge we’d all love to have, but handling a financial windfall intelligently isn’t as easy as it might seem.

Handled properly, the benefits and security of a financial windfall can last a lifetime. If not, it could cause more problems than it solves. If someone comes into money and that’s publicized, they’re likely to have friends and family and charities all pulling at them. The next thing they know, they look up and they don’t have a penny left.

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Financial windfalls can occur in a number of ways: the sale of a family business or a substantial property, an insurance or legal settlement, an inheritance, and yes, some people do win the lottery. The first thing to do is take a careful look at how much you’re netting, not getting, then figure out how the newfound wealth fits into your current financial situation.

Before you do anything, you want to know if the event is taxable or non-taxable. If it’s taxable, then you want to address the tax impact first so you know what you’re really dealing with. Then you look at your immediate financial situation. Do you need to pay off debt? Do you want to pay off your home? You want to get into a situation where you have positive cash flow. If you can accomplish that, then you can take a look at the extra money and make some decisions on what you might want to do with it.

It is important to note that very few windfalls occur without warning. People who are selling properties or are about to receive an inheritance or legal settlement generally have time to sit down and think about their alternatives. Some of the questions they should address include:

• How long will it be before I receive the money?
• What is the tax impact of this event?
• Do I need additional tax advice?
• What is my current financial situation?
• What are my short and long-term financial objectives?
• Can some of those objectives be fulfilled with this money and if so, which ones?
• If the event will be widely known, how am I going to handle requests for money?
• Do I want to devote some of this money to charitable giving and if so, how much?

Some experts advise setting a period of time during which you resolve not to make any significant decisions about how you will spend your newfound riches. A “cooling off” period helps people set priorities and avoid hasty moves which they may regret later.

Every individual’s situation is unique, so there are no “cookie-cutter” answers to how to handle a windfall. For some, a $250,000 windfall is a life-changing event. For others, that same amount would be very welcome but would not materially alter their lifestyle or financial goals. The recipient’s age, net worth, retirement savings, and emergency fund are just some of the factors to be considered.

Whatever the amount, it’s wise to talk with a financial advisor who can help you determine if there are ways to defer or reduce the tax consequences. For example, if the windfall will result from the sale of real estate, a tax-deferred 1031 like kind property exchange might be arranged for a similar piece of property. Or, if one of your goals is to take care of your children or grandchildren, the windfall can be leveraged by using the money to buy life insurance that names your loved ones as the beneficiaries (in most cases, proceeds from insurance are income tax-free). You might also want to look into a tax-deferred instrument such as an annuity or a tax-free security. Every case is different, so be sure to get specific advice.

People usually have not thought things through in detail. They think about the big things: “If I got a million dollars, I would pay off my house, take this fabulous trip and build this family member a home.” They think about the fantasy and they think much more about how to spend the money than how to save it. If you’re fortunate enough to receive a financial windfall, make sure you plan properly, so the benefits and security can last a lifetime.

Derek Ferriera CFP(r), CLU, CHFC, REBC and Martin Johnson are registered representatives of Lincoln Financial Advisors Corp., a broker/dealer, member SIPC, and they offer investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.

Derek Ferriera CA Insurance License # 0665169
Martin Johnson CA Insurance License # 0B69397

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