5 Steps to Manage Money from Sudden Wealth

Tax Planning | Life Events

 Peter Lazaroff By: Peter Lazaroff
Sudden wealth can throw us for a loop, especially if it's unexpected.

Unless you’re independently wealthy, you probably receive an income for work you perform at your job.

That income likely comes to you in a periodic fashion, either from regular paychecks if you’re an employee, monthly invoice payments if you’re a freelancer, or maybe even quarterly distributions if you own your own business.

Most of us are used to managing money in these predictable and steady patterns, which means unexpectedly receiving sudden wealth can really throw us for a loop.

“Sudden wealth” is just what it sounds like: money or assets you acquire all at once, and not necessarily with advanced warning.

Perhaps you received an inheritance, experienced a windfall from your equity compensation, went through a divorce, or found yourself holding a winning lottery ticket.

Whatever the particulars of this influx of money, you might suddenly find yourself with a lot of cash in your pocket that wasn’t there before – thoughtfully managing it is an important part of keeping it there.

The Psychological Impact of Sudden Wealth

Before we can even dive into the tactical ways to manage a big inflow of money, we need to address the mental component of suddenly coming into a significant amount of assets.

Regardless of whether fluctuations in wealth come from a positive or negative source, money has a power effect on people. You don’t have to worship your wealth for your money to be a close part of your personal identity.

Money, and coming by it quickly, is so powerful, that there’s even a term for what happens to people who experience it: Sudden Wealth Syndrome. If you weren’t living with some degree of wealth already, it’s worth acknowledging how jolting this change of circumstances can be.

That’s why your first action step may be to avoid taking any action at all, and simply acknowledge the mental impact of receiving an unexpected windfall. Only then can you then take the proper strategic steps to manage these funds well.

Evaluate Your New Financial Position

Your first impulse may be to go out and buy things, but there may be real needs and goals you can meet with the aid of your recent windfall. Supplementing income, managing debt, and saving for retirement are all legitimate considerations.

To determine the best first step, you need to take stock of your situation and identify existing threats to your financial wellbeing as well as opportunities to improve it. This will help you craft a viable financial plan that best allocates your newfound wealth.

Start by examining your current income and expenses each month and categorize the types of spending that are necessary versus discretionary.

Pay special attention to your debt expenses from student loans, credit cards, car payments, healthcare bills or anything else as you’ll need to figure out the best way to begin paying those down.

You’ll also want to take note of whether you are meeting your goals for retirement savings and building an emergency fund.

Build Out Your Financial Plan

The reality is that maintaining your new financial position requires a good bit of planning. The essential elements for a complete financial plan include exploring what matters to you most and establishing clear goals.

Financial planning is not simply about numbers; it’s about real life and pursuing your goals. Once you’ve identified what you want to achieve and when you hope to achieve it, here are five other steps you need to take.

1. Know the Tax Burden of Sudden Wealth

You can expect to pay taxes toward at least some portion of your windfall. Federal, state, estate, and capital gains taxes will each have a part in determining the size of what you may owe the next time you file.

Understanding how much you may owe will allow you to immediately set aside enough cash from the initial amount you received to cover your tax bill. You can then more freely plan with the net amount, knowing that you accounted for what you must send to the IRS.

Of course, good tax planning considers not just the taxes of today, but also the total taxes paid over your lifetime. That could include creating detailed tax projectionsbunching charitable donations, harvesting tax losses, or strategically using tax advantaged accounts.

You also want to be cognizant of your sudden wealth pushing your total net worth over the federal estate tax exemption, either now or at some point in the future. The exemption is $11.7 million for a married couple in 2021, but is widely expected to be lower due anticipated changes in tax legislation.

If you reach this number or will approach it in your lifetime, you might need to start thinking about strategies that help minimize estate taxes.

2.  Review Your Insurance Policies

You may want to re-evaluate your current insurance policies if you recently received significant cash or assets. Specifically, take a look at your umbrella liability policy to ensure it matches your current net worth (or consider getting an umbrella policy in place if you don’t have one yet).

Depending on the size of your windfall, you may not need coverage for death or disability insurance as you could essentially self-insure. If you still do need coverage, it’s likely for a reduce amount of coverage, so you might be able to find cheaper policies that better suit your current needs.

3.  Understand Charitable Giving and Family Lending Options

Easy on the wallet and conscience alike, charitable giving is an excellent way to manage your tax liability, but it’s a good idea to wait until you’ve come up with a financial plan that allows you to sort through direct donations to charities or strategic gifts to a donor-advised fund to manage your tax bill while benefiting your favorite causes.

If you decide to give or lend any money to family, put everything in writing. Keep in mind that giving (or forgiving a debt) more than $15,000 to an individual may result in you owing gift taxes on the transaction. However, you can pay unlimited amounts for someone’s education or medical bills as long as you are making the payment directly to the providing institution.

4.  Update Your Estate Plan

In the event of disability or death, estate planning allows you to manage and preserve your money so that it best fulfills your goals. It also means minimizing your taxes and creating financial security for your family. There are a few documents you should consider regardless of your age, health, and wealth:

  • will facilitates the appointment of a guardian for minors.
  • revocable living trust provides for the management of property in the event of incapacity (but not death) to allow for a more effortless transfer of assets to designated beneficiaries and sidestep the probate process following your death.
  • durable power of attorney—sometimes abbreviated as DPOA—allows you to appoint who you wish to manage your finances if you become incapacitated.
  • power of attorney for healthcare enables you to specify who you entrust to make medical decisions for you should you become sick or injured to the point of not being able to make decisions for yourself. 

Even if you have an estate plan in place, it is still best to revisit those documents every few years, particularly if your wealth significantly changes. This will help ensure everything remains up to date and current with your existing financial situation.

5. Invest for the Long Run

Choosing how to invest money from a windfall is an important decision, but the fear of making a mistake can make it feel overwhelming. Because nobody can know the perfect time to invest, there are two good strategies to consider.

The first is dollar cost averaging, which means investing a set amount on a regular schedule over time. Investing at regular intervals can be behaviorally advantageous because it reduces the risk of buying at the worst possible times and experiencing an immediate loss in value.

A second approach is lump sum investing, which means investing immediately and all at once. This approach has a higher expected return than dollar cost averaging because, historically, the stock market is up more often than it’s down. It also lengthens the amount of time your funds benefit from the effect of compounding.

Sudden Wealth Creates Opportunities and Complexities

While sudden wealth creates great opportunities, it can also introduce new complexities. With a financial plan that balances personal goals for the present and future, you’ll be ensuring your windfall stays soundly in place. For additional insights, download our free white paper on Evidence-Based Investment Insights: 12 Essential Ideas for Building Wise Wealth.

Next Steps

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This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

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Peter Lazaroff, Chief Investment Officer, first took an interest in investing when his grandmother gave him a single share of Nike stock for his 13th birthday. Today, nearly 20 years later, his investment insights are highly sought after by local and national media. More »