Receiving an inheritance, a legal settlement or prize winnings may seem wonderful, but it can also raise new problems. It’s important for recipients to use smart strategies that will help ensure the money continues to grow over the long term. This article offers some guidelines and advice for recipients that will help them avoid potential traps and pitfalls. It suggests that it’s a good idea to determine the tax obligations on the amount received, pay off any debt and increase savings before spending the money. The article points out that, with care, thought and planning and windfall can help provide financial security.
Coming into a large sum of money, such as from an inheritance, a legal settlement or prize winnings, may seem to be a wonderful bolt from the blue — but it can also raise new problems. How will you create financial security? What strategies can you put in place to help ensure the money continues to grow over the long term? Even a large amount of money can slip away fast without proper financial management skills. Stories of lottery winners who have lost all their winnings — over a period of just a few years — are more common than you might think.
Clearly, it’s important to avoid the traps and pitfalls that may await those who receive a sizable influx of cash. If you’ve suddenly come into a significant amount of money, consider these guidelines:
Wait. The best thing to do on receiving a large amount of money is to stash it in a bank or money market account for several months. This will give you time to identify goals and develop a plan for the finds. Waiting also helps moderate the desire to spend impulsively.
Determine the tax obligations. The government takes a cut of some windfalls, such as lottery winnings and certain legal settlements. And the government share can be a big one. To the extent your windfall pushes you into the top income tax bracket, you could lose 37% of that portion to federal income tax. There could be state or local tax liability as well.
Pay off debt and boost savings. Paying down debt can provide a higher return than many other investments, especially if it’s high-interest-rate debt and the interest isn’t deductible, such as that on credit cards. Establishing or boosting your savings minimizes the need to incur future debt.
It’s important to keep working. Few windfalls are large enough to see anyone through to retirement or death. Until you have a solid handle on the amount available after taxes and debt and have identified solid financial goals, you won’t know if you can quit your job.
In addition, consider where you’d like to be five, 10 or 20 years into the future. Develop a budget that will help you move toward your goals — whether that means retiring early, starting a business or something else.
Finally, be careful when asked for money. Friends and family members may expect to share in your bounty, and charitable organizations may ask for donations. The ability to support worthwhile causes or loved ones in need is a real benefit of a windfall. At the same time, if you accede to every request, you’ll quickly deplete the funds.
Enjoy your good fortune.
It’s OK to splurge a little and spend a small portion — say 1 % to 2% — of your windfall on something you enjoy. Just recognize that you don’t want to blow the entire amount on frivolous items that provide neither lasting satisfaction nor a sound foundation for the future.
Receiving a large amount of cash is a nice problem to have. With care, thought and planning, it can become a real solution and provide genuine support when you need it down the road. A financial professional can suggest strategies that can protect your windfall and make it grow.
Sarah C. Krick, CPA | CFE | CITP
She specializes in SSAE 16 engagements, SOC engagements, and tax services for individuals and trusts. Sarah also has experience in financial statement audits, attestation engagements, and tax services for corporations and non-profits.