Five tips for managing a financial windfall

What is a windfall?

Many people spend countless hours dreaming of lucking into a large sum of money. Maybe it is winning the lottery, getting a large inheritance from some unknown relative, or even selling your business for much more than you expected. While it might sound like a pipe dream, it is a relatively common event (especially for inheritances), and it requires extensive financial planning. For many people, dealing with an actual windfall can be fraught with difficulties that if aren’t managed properly, could lead to unexpected tax bills, family problems, and extreme money mismanagement.

Many people have heard the horror stories of people squandering their lottery winnings, or young professional athletes going bankrupt before the age of 30. The problem for many people is poor personal finance habits don’t suddenly go away once you receive a large amount of money. In fact, it often exacerbates the problem, as excessive spending and poor decisions tend to increase among people that were never taught money management skills.

The National Endowment for Financial Education (NEFE) estimates that upwards of 70% of people that receive a large sudden money windfall will lose all of it within several years. How do you avoid becoming one of these people? These are my tips to help you make the right decisions if you’re in this fortunate situation.

Five Tips for Managing a Financial Windfall

1.) Wait at least six months before making any large financial decisions.

I have found that many people make very impulsive decisions after a windfall because they overestimate dollar amounts and don’t factor in taxes and other expenses related to their new situation. The worst thing you can do is impulsively quit your job (losing benefits along the way), buy new houses, and start spending extravagantly right away. A waiting period allows you to think harder about your decisions, make a financial plan with a professional, and get a solid estimate for taxes and other expenses.

2.) Work with an ethical financial professional on a plan.

When word gets around that you have come into a large sum of money, you can expect many outstretched hands looking for a piece of the pie. Some of those will be family and friends, but others will be the vultures of the financial industry: life insurance salespeople and name-brand brokerage firms with names like Raymond, Edward, Jones, James, and Merril. It will take some due diligence on your part, but it is important to get involved with a fee-only fiduciary that doesn’t sell products and can help build a plan with you. Independent financial planners that have qualifications such as a CFP® are a great starting point.

3.) Invest for the long-term.

Once you have your financial planning team set, it is time to start implementing your plan, which should be focused on long-term growth and stability. That means investing in retirement accounts to take advantage of compound interest, developing a plan for generating income from your investments, and most importantly, investing in yourself. That could mean continuing your education, developing a career or passion, and investing in your family’s future with a will, trust, insurance policies, college savings plans, and other items designed to protect your lifestyle over time.

4.) Define your financial goals.

Many people that receive a large financial windfall don’t have clear goals before they start spending. That means the default is to buy everything you ever wanted without considering the repercussions. But if you have a well-defined plan, it is easier to make decisions that fit into that plan. There is intentionality with the money, and accountability if you deviate from the plan. Your new assets (and income) should be assigned to specific buckets- such as discretionary spending, home improvement, living expenses, retirement savings, paying debt and so forth. Those buckets will be informed by your long-term goals, such as starting a business, retiring by a certain age, purchasing a new home, paying for a college education, or just becoming financially independent.

5.) Use good judgement when gifting to family and friends.

There will be many people approaching you with loan requests, business investment ideas, and emotional pleas if it is public knowledge that you received a financial windfall. It is good practice to be private about your financial situation to avoid some of these issues, but you need to develop and stick to a plan for gifting. Generosity is of course a virtue, but people will exploit your generosity if you let them, even if it leads to your financial ruin. Together with your financial planner, define at the outset the closest family or friends that you would like to gift something to. Make it very clear it is a one-time gift (don’t ever bother making loans), and once it is done, stick to your guns. Don’t ever gift anything you can’t afford, and you should think long and hard about making any gifts at all, depending on your financial situation.

You need to be especially careful to vet strangers and financial “professionals” that might actually be active scammers trying to take advantage of your situation.