By: James Philpot
The recent record Powerball jackpot prompted many fun discussions about what we would do with a nine-figure payout. One recent discussion reminded me of my school days, when my investments professor asked the class what we would do if someone gave us $100,000. One by one, we answered that we did not know, until one student said, “I’d go to Hawaii!” The class laughed, but the professor commended that student and chided the rest of us for not having a ready plan. In this column, I discuss some aspects of planning for financial windfalls.
Although most are far smaller amounts than the recent Powerball jackpot, financial windfalls happen frequently. Common financial windfall sources include inheritance/life insurance, legal award/settlement, job signing bonus/severance pay, unexpected year-end work bonus, generous gift and others. While pleasant, windfalls can be overwhelming and can even create problems. Financial experts offer several common and practical suggestions for handling a financial windfall. Here are a few.
Do (and say) nothing for a few months. Keep your regular job, avoid additional spending and park the money in the bank for a while. A windfall can be a big life event, and big life events temporarily color our judgment. Especially with an inheritance or life insurance proceeds, waiting allows us to get through the grieving process before we make financial decisions. Also, unless you want to meet hundreds of previously unknown friends and family members and learn about their financial needs, keep your mouth shut.
Form a financial team. A trusted team of financial professionals can help you form a concrete plan for your new wealth. Even if you do not already have a financial planner, you probably have a banker, insurance agent or accountant whom you already know and trust. They can start your plan and give you referrals if your needs are beyond their offerings. Be wary of solicitations from anyone you do not already know and firms you have never heard of.
Determine and fund the tax bills. Depending on the source and amount of the windfall, there may be income, estate or gift taxes to be paid. Rest assured, governments will be first in line among your creditors to get their money. An accountant can evaluate your tax situation and forecast the tax bill, if any. File and pay applicable estimated taxes and you will not need to worry about the government.
Separate the windfall funds. When we separate monies into different accounts, we tend to think of and treat each account differently — “That’s our rainy day fund,” or “That’s the college fund.” Placing a large windfall in a separate account (or even a trust if the amount is enough) will force spending from that account to be a deliberate decision with an immediate, known effect. This makes overspending a windfall less likely than if you placed the money in your regular checking or brokerage account.
Treat yourself a little. Diet gurus often advise that small, occasional treats can help a dieter avoid major deviation from healthy eating. The same can be true for a financial windfall, as long as it is well planned and kept to a limit — say 2-5 percent of the balance.
Beyond these, there are many good things that can be done, including reducing debt, funding other needs and generating additional income. Your financial team can help you set and meet these goals.
Dr. James Philpot is a certified financial planner and is associate professor of finance at Missouri State University.
This article appeared in the February 27, 2016 edition of the News-Leader and can be accessed online here.