There are a few broad categories that trigger people to reach out to me.

Retirement Planning is biggest. Major life changes (marriage, divorce, having kids) is a common reason, too.

Another one, albeit slightly more unique: “I have a good handle on our finances, but I want to get you involved because my spouse needs someone trustworthy. If I get hit by a bus, I want you already involved to fully take the reins.”

But somewhere in the Top 5 most common reasons is the rationale for today’s article:

“I received a BIG sum of Money…and I have no idea what to do next!”

Let’s talk through the good ideas, bad ideas, and ugly pitfalls to avoid when it comes to receiving a windfall.

Where Does a Windfall Come From?

Your definition of a windfall will differ from mine. Some people consider $1000 to be a windfall. Others wouldn’t flinch at receiving $100,000. It’s in the eye of the beholder.

To me, a windfall fits one of these two loose definitions:

• Enough money to meaningfully change the timelines of your financial plan. The kind of sudden money that dictates, “Oh – I think we can retire years earlier than expected now,” or perhaps something like, “Can we actually buy our dream house now?” It’s that kind of money.
• Enough money to make you suddenly anxious. Usually, that means either 1) more money than you’ve ever been around and/or 2) enough money that you can’t stop thinking, “Don’t screw this up!”

A windfall usually comes from one of the following sources:

• Inheritances: often including the decedents Retirement accounts and assets held in trust.
• Gifts: ranging from annual gift exclusions up to the lifetime Estate tax credit limit.
• Sudden changes in income / company structure: bonus payments, various types of stock options, or cashing shares in an IPO.
• A big sale: Real Estate sales and business sales being two of the most common
• Divorce: while perhaps not “receiving new money,” a divorce frequently results in at least one of the divorcees needing to take a more leading role in their finances for the first time in their lives.
• Lottery winnings, insurance settlements, and other “one off” events: while less common, people do come into large sums of money in unique and unforeseen ways.

Should I Expect a Future Windfall?

Here’s a common thought I hear during the financial planning process:

“My grandmother is 81, and my mom says Grandma has a lot of money. So, whenever Grandma dies, I’m going to inherit a lot of it. Knowing that, I’m pretty comfortable with my financial situation.”

Brittany, who counts her chickens early

This thinking begs the question: is Brittany right to include her future inheritance as part of her financial plan?

As with many financial planning topics, the best answer is, “It depends.” On one hand, overlooking a “sure thing” inheritance would be terribly conservative. But to include an inheritance that never materializes can torpedo your plan.

Going back to Brittany, here’s what I’d want to ensure to then confidently include an inheritance in her financial plan:

• There have been clear family discussions about how Grandma’s money will be distributed.
• Brittany (and her financial planner) have copies of Grandma’s estate plans
• Brittany (and her financial planner) have a recent copy of Grandma’s net worth statement, or other evidence to inform just how much Brittany will receive,

Too often, though, someone wants to include an inheritance in their financial plan despite them lacking any knowledge of what the inheritance will look like, or lacking the evidence as to whether they’ll receive anything in the first place. That’s a recipe for disaster.

In summary: if you know your future inheritance is a sure thing, go ahead and include it in your plan. Short of that “sure thing,” I wouldn’t count on it.

Important Stuff First

What should you do when your receive a windfall? The National Endowment for Financial Education covers the topic pretty well:

• It is usually not necessary to make many decisions immediately. So, allow yourself time to adjust to your new situation.
• You may find it beneficial to decide how much you will need to live for the next six to 12 months and keep that money separate from the rest of your windfall.
• You can put your money in a temporary and safe account—a certificate of deposit or money market mutual fund insured by the FDIC will provide a safe and relatively liquid place for your money.
• You may need to get tax advice so that you can determine if there are any immediate actions you must take because of tax repercussions.

Let’s talk about that last bullet: does a windfall create scary tax implications?

Tax Implications

Windfalls can come with tax scenarios that the average person simply hasn’t encountered before.

You may need to file estimated taxes. There can be complexities surrounding distributions from retirement plans, inheritances, and lottery winnings. Exercising stock options is another tax tangle.

It makes sense to get help in this department. Typically, a CFP financial planner can point you in the right direction. Ultimately, a CPA accountant or other tax-preparer will help you file your taxes each year.

Remember: the US tax code is progressive, meaning that you’ll pay a higher proportion of taxes as your income and net worth increases. Thus, after receiving a windfall, proper tax planning becomes more important for you than ever before.

Common Pitfalls

How do people mess up their windfalls? Many different ways.

Sometimes, people are simply ignorant to what they ought to do – the classic “I don’t know what I don’t know” scenario. Common reasons here include:

• Failures to plan (especially doing proper estate planning)
• Failure to understand and pay taxes on time.
• Lack of understanding of investment products (…the number of stories of windfalls going directly into annuities is shameful)
• Going it alone. Not knowing you can/should engage with professional expertise.

Other mistakes, of course, are “hands on” acts. Common mistakes here include:

• Spending extravagantly. New cars, big houses, etc. until the money is suddenly gone.
• Giving away too much to family, friends, etc.
• Investing hubris, or conflating sudden wealth with the ability to intelligently invest.
• Quitting a job, or otherwise harming outside income streams.

Receiving a windfall is a tremendous Stroke of luck. Do not let one of these common pitfalls turn that luck on its head.

What Should You Do Instead?

Here’s how I’d guide someone who just received an unexpected windfall.

Debt Management, Emergency Fund, and Other “Order of Operations”

First, I’d consult the financial order of operations. It’s a simple, long-standing heuristic in the financial planning community that prioritizes an individual’s financial needs.

It might suggest, for example, that our inheritor first creates an emergency fund and pays down some high interest debts, before then deciding to invest the remainder of their money toward their long-term goals.

Financial Planning and Investment Management

But how should they invest? Well, that’s a function of their financial plan. If our inheritor doesn’t have a financial plan, they need one.

Quite simply, a good financial plan should combine the various puzzle pieces in a person’s financial ecosystem with their unique goals and values. A financial plan combines all the numbers with all the soft stuff.

Only after a cogent plan is in place can someone understand how they should be investing (let alone how they should be investing a large sum like a windfall).

Lifestyle Upgrades and Big Purchases

I understand the desire to immediately spend a portion of a windfall on Lifestyle upgrades or large self-indulgent purchases. But I’d caution you against going overboard.

First, set a limit for yourself. Something like 5-10% of the windfall.

Second, ask yourself the important question: will this “one-time large purchase” actually lead to a longer outflow of on-going maintenance costs? Is it truly a one-time purchase, or is it forever lifestyle inflation?

Estate Planning

A large windfall might beg a second set of important questions: what if you kick the bucket?

Check out our Estate Planning 101 primer for more details.

Giving

Do you want to “pay it forward?” Good for you! It’s probably better for the world than buying that decked-out pontoon boat.

Nevertheless, give wisely. It might be worthwhile to consult a philanthropic expert, an estate attorney, or an experienced financial planner to ensure that your gifts benefit your charitable causes and do so while maintaining your best interests.

Sign Here…

When you receive a windfall, careful planning and mindful decision-making can help you maximize its positive impact on your life.

There’s no rush. Don’t do anything stupid. Lean on trusted professionals to fill in your gaps in knowledge.

Thank you for reading! If you enjoyed this article, join 8500+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week. You can read past newsletters before signing up.

-Jesse

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Jesse Cramer Writer & Financial Planner

Jesse Cramer is the writer of The Best Interest blog, the voice behind The Best Interest Podcast, and works full-time as a fiduciary financial planner for Cobblestone Capital Advisors in Rochester, NY.