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Sudden Wealth: What to Do When You Get a Lump Sum of Money – And What Not to Do

Allocation Investments

Suddenly finding yourself with a large sum of money can be exciting! But if not handled correctly, it can be dangerous.

Whether you’ve received an inheritance, a large bonus, lottery winnings or a windfall from some other source, a large sum of money has the potential to change your life. You might decide to upgrade a home or car, save for your children’s education, start a business or pursue more financial security. However, if not managed properly, a sudden large sum of money can create a new set of problems.

Having a lot of money all of a sudden can lead you to make impulsive purchases. Some lottery winners, for example, have declared bankruptcy within several years of getting their money, partly because of binge buying.

Suddenly having a lot of money can also make you feel like your prior standards of savings and investing are no longer relevant. You may be tempted to stop regular savings and retirement savings contributions, for example. While that might be OK, depending on your new level of wealth, it might also be an inadvisable move that will hurt your financial security in the long run.

Another issue we’ve seen is those who find themselves with a new windfall of cash may suddenly feel no need to plan, when in fact, sudden windfalls kick off a whole new need for planning.

So, if you do find yourself in this situation, what should you do? What shouldn’t you do? What do you need to ask yourself?

What Not To Do:

Don’t make any drastic changes right away.

It’s a good idea to delay making any large moves with your new funds. Don’t suddenly quit your job, for instance, or purchase a Rolls Royce. Talk with a financial advisor about placing the money in a money market or Certificate of Deposit (CD) for six months.

Impulsive moves don’t always pan out. For example, what if you quit your job and then find you’re really bored? What if you buy a ski chalet, only to find unlimited skiing is not the dream you’ve always thought it would be?

You also want to avoid the temptation to buy things that aren’t going to benefit you or even really be what you most want in the long run. A new car for your favorite great-aunt or an investment in a local start-up could both be great ideas. But a string of such purchases might deplete your windfall more than you expect, leaving you with less to make other, more lasting, moves.

What To Do:

Create a financial plan for your new wealth.

During the period your cash is parked in a money market or CD, create a financial plan for the windfall. Be sure to talk with a financial advisor about tax implications. The tax implications will vary depending on what the windfall consists of (cash, stocks, bonds, real estate, etc.) and how you’ll receive it. While an estate tax will only kick in if you’ve inherited more than $11.18 million (or $22.36 million for a married couple), the amount might raise your income tax bracket in the short term.

It’s also a good idea to talk to a financial advisor about how you’ll receive the wealth (lump sum or periodic payments) and where to keep it. An advisor may recommend a continuation of money market/CD or suggest an investment in other assets.

An advisor can also offer advice on how to best to use your money. Think through what your goals are and what you most want to do.

 

Recently receive a hefty inheritance or suddenly come into a large sum of money? Align Wealth Partners has clients who may have had the same questions you do. Contact us to see how we can help.

 

What To Ask:

Can you pay down or eliminate debt?

It can pay to look at your debt situation. The average American owes a record amount of credit card debt, at $6,028. Credit card interest is currently high, as well. If you owe credit card debt, can you pay it off with this newfound money? If so, you may free up several hundred dollars in monthly cash flow for the long term. Even just reducing debt can lead to more cash flow in your wallet.

Credit card debt, of course, is not the only form of debt though. For example, does it make sense to pay off your mortgage with this sudden wealth? While a mortgage does confer some tax advantages – the interest is deductible on a mortgage of up to $750,000 – the advantages of reducing mortgage debt can be the same as those for credit card debt: More money in your pocket every month that isn’t going toward debt service. A paid-off mortgage, too, means that you own your house.

Can you use the money to max out your IRA?

Retirement savings are important. A sudden windfall can hike your taxes, so maxing out your Individual Retirement Accounts (IRAs) can be a double benefit: A traditional IRA contribution adds to your retirement savings and can provide tax advantages in the year of contribution.

You may be able to contribute to a Roth IRA as well. A Roth IRA won’t give you tax advantages in the year of contribution, but its appreciation and capital gains over the years grow tax-free, and any withdrawals will be tax-free when it’s time to use the money at retirement age.

You can contribute up to $6,000 to IRAs in 2019. If you’re 50 or older, the maximum rises to $7,000.

Should you start or add to an emergency fund?

Having a robust emergency fund that could tide you over six to nine months is a standard part of a financial plan. Using part of your sudden wealth to grow an emergency fund may be a good use of the money.

If the sudden wealth has made you very comfortable in terms of cash flow and income, an emergency fund may seem counterintuitive. However, studies show that a surprising number of Americans don’t even have $400 if they need it for an unexpected event, such as a car repair. Even higher-income Americans feel this. Why? While the $400 needed might actually exist, people tend to already have it earmarked for another use (debt payments, for example), so they don’t feel it can be deployed for an emergency. The key, it seems, is to have enough liquidity to cover the unexpected. Assess whether you do, and if not, you may want to consider putting some of your new money in an emergency fund.