10/17/2024

Five Tips to Navigate Receiving a Windfall

Written by Geoffrey Schaefer, CFP®

Receiving a windfall changes your financial situation overnight.  There is a lot of opportunity that exists in these events, but many challenges as well. Many recipients of a financial windfall act too quickly or become paralyzed and fail to take any action at all. What is the proper way to respond to receiving a windfall?

What exactly is a windfall? A windfall is a sudden receipt of assets (often a large amount), sometimes expected and sometimes not.

Common sources of financial windfalls are:

  • Inheritance or Gifts
  • Legal Settlements
  • Business Sale
  • Gambling Winnings
  • Stock Liquidation

In all these cases, assets become liquid and available to the recipient quickly and usually change their net worth and ability to give, spend, invest, etc.

So, you get a phone call that you’re receiving millions of dollars, what could go wrong from that? You would think it would be simple, but many financial planners have seen clients spend down or squander windfalls at alarming and surprising rates. Lavish spending habits, large unreasonable purchases, unrealistic expectations of what that level of wealth affords, and lack of a foundation in values all can lead to pitfalls and missteps with found wealth. 

How can we navigate receiving a large sum of money in the most prudent way possible? Here are a few ideas:

  1. Don’t change anything right away.  Many windfalls involve life changing money, but a dramatic lifestyle change, or large expenditures may jeopardize the sustainability of those funds in a long-term plan.  In general, money received from a windfall, especially inheritances, gambling winnings, or settlements, is spent more easily than money that is earned, saved and invested over decades. You see this in the fact that one third of lottery winners go bankrupt within five years. 78% of NFL players face financial hardship and nearly 16% go bankrupt after leaving the league. In the case of inheritance, only 10% of wealth passes to a third generation. The best thing you can do when you receive a windfall is pause until you make a thoughtful, values driven plan.
  2. Understand your emotions. This one may seem irrelevant, and you may be asking, “isn’t this a financial post?”  The human element is incredibly important to navigate.  In the case of a legal settlement, you may feel relief. In the event of an inheritance, you may feel guilt, anxiety, confusion and sadness. If you win the lottery, it may be ecstasy followed by disbelief. None of these would be abnormal, but your feelings are unique to you and those feelings could be pointing to values that direct decisions yet to come. Listen to how you feel.
  3. Anchor to values.  A value is a standard or judgment that you use to determine what is important in your life.  While some values like life and freedom are universal, most are relative and vary from person to person.  If you value something, it likely won’t change if you are worth $500,000 or $50,000,000.  How you address those values could change dramatically. Perhaps championing the homeless or protecting the environment were causes that mattered greatly to you. They will likely still matter to you after the windfall, but how you address them and support them within your financial plan can change.  The money changes your plan, it shouldn’t change your values.
  4. Understand what you received and the taxation of that asset. Taxes are a huge expense throughout your lifetime. A business sale could be a huge taxable event, while an inheritance from parents may result in next to no taxes.  The taxation of your newfound money varies greatly depending on the source and the vehicle. Understanding what you have after taxes is key.  In some cases, like installment sales of a business or the receipt of an IRA, you can spread out some of the tax liability and benefit from ongoing planning. Don’t charge ahead planning on a pretax amount as that will only lead to disappointment when the after-tax amount arrives.
  5. The only timing is your own.  Should your portfolio be allocated differently at $20 million versus $200,000? Maybe. If you receive a large sum, can you buy that new car? Probably. Can you spend more monthly with your annuity payout? Most likely.  When should you do this? After you take a few weeks to a few months to pause, recenter on your values and build a plan, there is no timeline.  Your plan may require a portfolio overhaul. Your ability to retire may move up by a decade. You may be able to gift a large sum to a charity.  If your plan is built on the alignment of your newfound capital to your values, the only timing that matters is when you are confident and ready.  Important parts of the financial plan would include:

With every source of windfall this is different as they all involve different emotions. In a business sale or settlement, maybe it’s weeks.  With the loss of a loved one, maybe it is months or even years. Make a plan with a trusted advisor that allows you to take the time you need to make these decisions, most of which are brand new to you.

Financial windfalls are life changing. Do not let the stress of decision making overwhelm you to the point of inaction. On the opposite side of the coin, do not let the newfound purchasing power let you slip into outspending what you truly value.  A financial plan is important for every family and in this case, it is invaluable.  If you encounter a windfall, make a plan before you make financial moves.

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