Suddenly Wealthy: Financial Planning Tips for Managing a Sudden Inheritance or Windfall
A significant number of people who receive a large inheritance have little to show for it within several years. Unfortunately, most people are not prepared for the tremendous amount of emotional stress, the changing dynamics of personal relationships and the heightened complexities of financial management that accompanies being suddenly thrust into having wealth.
Sudden wealth can take an emotional toll.
There’s a vast number of conflicting emotions that can overwhelm those who suddenly acquire wealth. The newly wealthy often are suddenly overwhelmed with unsolicited advice, a multitude of potential investment opportunities and loan requests, and financial planning tips from friends and family. This can result in distrust and fear of the true motives for others, even for those within one’s inner circle. When receiving an inheritance, the loss of a loved one is already a potentially devastating event, but that coupled with possible feelings of paranoia, unworthiness and insecurity for not having earned the money is more than most people can handle. Young adults informed of being named beneficiary of a large trust may feel resentment toward their benefactor, given that they were kept in the dark about the money. If they’d known earlier, they may have made different life/career choices.
Even many business owners who sell their business are not immune to the emotional perils of a sudden influx of wealth, despite what might be years of financial planning and preparation. With a pile of cash in place of what was the business they built from the ground up and managed seven days a week, there’s often a sudden loss of identity and purpose in the months if not years after the business sale.
Here are some Planning to Wealth best practices that help people deal with this sort of challenging financial change:
1. Take a Time-Out. Resist the temptation to jump on immediate investment opportunities, quit your job, start that expensive home renovation, or buy that expensive sailboat for at least six to nine months. Those decisions, purchases and investments would be emotional financial decisions, and financial management is always at its worst when emotions drive decisions.
Moreover, many people tend to spend inheritance money more frivolously than money they’re personally earned and saved. This “mental accounting” means many people that have inherited money tend to view the assets as found money, so they tend to slack on fundamental saving, budgeting and spending habits. People with newfound wealth should keep this top of mind as they start to think about how they will spend their wealth.
What you really need is time to gain some perspective and sort out the emotional stresses of a big inheritance or windfall. Take a vacation with your family to relax and clear your head.
During this initial phase, it's probably best to keep your sudden wealth relatively quiet and to avoid making any sort of financial commitments to family and friends. Your sudden wealth could bring out the worst in people as family, friends and/or strangers may be looking to cash in on your newfound success. Discretion about your new situation may attract opportunistic lawsuits, dubious investments or even worse, like threats to your safety.
While discretion is important, it’s important to continue to participate in the activities and social interactions you enjoy. Many people with newfound wealth withdraw from society, friends and family due to the stress. You’ll need activities you’ve always enjoyed to reduce stress and anxiety, just resist the urge to pick up the tab more often than before the inheritance.
During this initial time-out phase, don’t feel the pressure to invest your money right away. Putting together an appropriate investment and asset allocation plan in place should probably come later. Perhaps it makes sense park the funds in liquid, safe investments until after your initial cooling off phase ends. For a $1,000,000 inheritance, one route to take would be to put $250,000 into four bank savings accounts each to stay within the FDIC coverage limits.
2. Investigate Potential Lifestyle Changes. As time passes, it’s best to start making a list of purchases and attaching dollar values to them, and to start to investigate the viability of larger decisions. For example, this is the time to rent that sports car you’ve always dreamed of to see if it makes sense to buy it down the road. If you’re thinking of quitting your job and working in the nonprofit sector, it’s best to start by volunteering first.
During this period, it’s important to have a frame the sudden money funds in a less traditional way. Instead of thinking of the inheritance as an asset, we encourage people to think of it as a long-term stream of income. For example, it’s not $1,000,000, it’s $40,000 of income per year for life, assuming an annual 4% spend-down rate. This reframing can help maximize the impact of the funds and help you avoid pitfalls.
3. Build Your Team. Finding the right mix of tax, legal, estate, risk management, and financial advisors can lay the right foundation for effectively managing your newfound wealth. The financial tax and legal implications of an inheritance/windfall are complex, and you need to be sure that you have a team of objective and skilled financial advisors with your best interests in mind. With the right team in place, you’ll maximize your money so that it lasts as long as possible. Moreover, you’ll need a team that understands and respects that you probably won’t make decisions quickly at first, since you’ll need to think through your new situation. It may make sense to also seek out a therapist to deal with some of the emotional issues of a sudden windfall or inheritance. Your CPA or tax specialist is probably the first person to add to your team, since you could have a large tax liability related to the inheritance or windfall and want to set aside that money early on.
Investigate each financial planner’s background, expertise and approach to ensure that not only that they have the right skills but can provide you with the service you deserve. Make sure to understand clearly how your advisor is paid and if they are a “fiduciary.” Non-fiduciary advisors aren’t legally required to put your interests first, and advisors compensated by various product providers are likely compromised from giving truly objective advice.
Preview the client experience by checking references and by having trial meetings with prospective advisors, and check to see if there is any disciplinary information on the advisor's regulatory body, like the state bar association for attorneys, the state board of accountancy for CPAs and the SEC's Investment Advisor Public Disclosure website for financial advisors. (For more, check out Top 5 Tips for Choosing the Best Financial Advisor)
As you build your team, it’s important to also learn more about investing and financial management. This will help you have more substantive conversations with your financial advisor and help you successfully manage your wealth. Most people take decades to build a nest egg, and so they build their financial literacy skills slowly and steadily over time, and have the luxury of making mistakes earlier in their life when the stakes are higher with smaller sums of money. People receiving a sudden windfall or inheritance don’t have that luxury, so building financial management acumen should be a strong focus of you and your team.
Some would argue for having all of your advisors under one company to save time on coordination between the advisors. However, that may not be the best idea as having your legal, tax and wealth management advisors belong to different companies can help create a system of checks and balances where ideas, strategies and the various team members themselves are evaluated objectively by other members of the advisory team.
Your team can also help ease some of the anxiety and aggravation in dealing with the numerous solicitations that you’ll likely receive to borrow money, donate to charity or invest in business ventures. Any of these requests can be funneled through your advisors, which will leave you more protected and likely in a better long-term financial position. A strong team in place will also help deal with any frivolous lawsuits or threats to your safety, and can be helpful sounding board on very important life and financial decisions.
4. Plan for the Future. With a team in place, it’s time to translate the windfall or inheritance into sustained lifelong wealth. The first part of the planning process is getting a clear understanding of what's important to you and what goals you'd like to accomplish with your newfound wealth. You may want to pay off all your debts, set up a trust of foundation, give more to charity or pay for the college education of loved ones. Once you've established these values and goals, you can work to set up a plan so that what you do with your money aligns with those goals and values going forward.
When financial planning for your inheritance, you’ll think through the answers with your advisors to important wealth management questions. What will your asset allocation look like? How much will you afford to spend on a monthly basis? Is the wealth you have now enough to be financially independent and retire early? How do you ensure that your newfound wealth won’t negatively impact your children, family, and friends?
There are five key elements of financial planning: 1) expenses 2) investing 3) protection 4) debt management, and 5) tax planning. A good financial plan should address all five areas for your specific circumstances. In expenses, you’ll set up a budget and do cash flow projections. The investment plan should address where assets should be allocated and what sort risk you’ll be taking. In protection planning, you’ll address insurance coverages to guard against unforeseen events like lawsuits and natural disasters, and you’ll also structure your estate planning to minimize probate and ensure that your wishes are carried out when you pass away. The debt management plan will help address paying off debt and minimizing interest costs, while a proper tax plan will help minimize tax costs over time.
Our experience has been that the four most common ways people with a windfall or inheritance lose it all are: 1) giving too much money away 2) spending too much 3) unexpected events like lawsuits, divorce or natural disasters, and 4) poor and imprudent investing. Proper planning can help minimize all four of those pitfalls. Oftentimes, people will buy investments that are accompanied by a lot of expenses. Buying that new real estate property may end up being an attractive investment, but many real estate investments come with additional expenses and risks.
5. Implement Strategies and Behaviors for Success. With your team in place and a clear understanding of what’s important to you, implementing your wealth management strategy can put your inheritance on the path to success. It’s best to address the most time sensitive items and play defense first. Given that you have more to lose now, you’ll likely would want to increase the insurance liability coverage on your home and car, and take out an umbrella policy to further protect yourself. An inheritance is considered separate property in most states, so depositing this money in a non-joint account would help protect you in the case of a divorce. You’ll also want to have extensive conversations with your team on drafting and implementing an estate plan that adequately protects your assets, minimizes future taxes, ensures that your assets are distributed according to your wishes and avoids probate.
True self-awareness and discipline can go a long way when it comes to a lifestyle you’ll maintain going forward. Most people don’t have the self-discipline to successfully receive a large influx of money and maintain life-long sustainable spending habits, so you might want to consider working with your team to restrict access to some or all of your sudden wealth through a trust structure. We also recommend prioritizing most of your initial inheritance spending on long-term, high value areas, like funding retirement accounts and paying off debts, over life. If one of your goals is to pay off your debt, it’s best to start with the highest interest rate debt first.
As you think through your investment plan, be mindful that imprudent investing and outright investment scams are one of the largest pitfalls for people receiving an inheritance or windfall. Be especially mindful of any investment that guarantees returns, promises quick profits, unusually high returns and/or there’s high pressure to invest right away. If it sounds too good to be true, it probably is.
Inherited Asset Considerations. Each inherited asset will bring its own unique tax, legal or other considerations.
Individual Retirement Accounts (IRAs) — IRAs have very specific rules regarding their taxation and distribution, depending if the person that inherited the money was the spouse or non-spouse. One of big pitfalls in this area is beneficiaries receiving a lump-sum distribution, which can result in a very large tax bill relative to other distribution methods.
Securities — securities receive a step-up in basis at death, so the tax consequences of inheriting securities can be much less severe than IRA funds. Sometimes, inheritors will hold on to particular securities for sentimental reasons exposing them to securities that don’t make sense for their portfolios.
Real estate — real estate receives also a step-up in basis, so it’s best to get a new appraisal on the asset to memorialize current property’s valuation.
Insurance — insurance proceeds are received tax-free.
Smart Gifting Strategies. As people receiving an inheritance or windfall are often very generous to their family and friends, often to the detriment of their financial stability and success, there are some strategies they should consider:
Annual gifting — some people aren’t aware that gifts above the annual gift exclusion ($17,000 per person in 2023), a gift tax may be owed. If you’re going to give more than the annual exclusion, you might want to “gift split” it with your spouse so that you can give up to $30,000 that year without gift tax consequences.
Loan cancelations — a thoughtful gift can bring unintended consequences. For example, if you cancel an existing loan to a family member, you as the gift giver may have a gift tax situation and family may have taxable income equal to the amount of the forgiven loan.
Charitable giving — if done strategically, charitable giving can have meaningful impact, large tax benefits and discretion if necessary. For a comprehensive report on charitable giving financial and tax strategies, click here.
Overall, with proper financial planning for your inheritance and a thorough understanding of the potential pitfalls, receiving an inheritance or windfall can provide you and your family with sustained financial security and a bright future.
David Flores Wilson, CFP®, CFA, and Dann Ryan, CFP® are New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioners & Managing Partners at Sincerus Advisory. Click here to schedule a time to speak with us.