Next steps after a sudden wealth event or cash windfall
Wondering what to do with a sudden financial windfall? Whether the windfall was expected, perhaps from the sale of a business, or unexpected, you’ll want to build a team of professional advisors and make a plan for the future. While you assemble your team, hold off on making any major purchases or decisions until you’ve had time to consider your options.
Deciding what to do with a cash windfall always comes down to your personal goals and financial situation. And ultimately, investing newfound wealth depends on a number of factors, including your risk tolerance, time horizon, and spending plans. Sudden wealth events rarely happen more than once during someone’s lifetime (if at all), so proper financial management is essential.
Types of sudden liquidity events
When someone experiences a life-altering financial windfall or increase to their net worth, it’s often called a sudden wealth event. There are many different types of financial windfalls, for example:
- Receiving an inheritance
- Stock options or equity compensation
- Sale of a business
- Lottery winnings
- Asset division in a divorce
- Proceeds from a lawsuit
- Professional athletes (signing bonus, performance, sponsorships, etc.)
A sudden wealth event or large cash windfall can change your life. So it’s important to step back and take stock of what it might mean for you. Goals often change when the realm of what’s possible expands. To help ensure you’ll have all options available to you, try to delay any major purchases or financial commitments until you have a financial plan.
Managing an unexpected windfall or sudden liquidity event
How to best use the proceeds from a windfall depends on a number of factors unique to your situation and the type of lump sum you received. Broadly, you have options for the proceeds: save it, spend it, invest it. In many situations, the best approach will be some combination of the three.
3 key steps in managing a financial windfall
- Start building your professional advisory team
- Understand the tax treatment and planning opportunities before acting
- Delay large purchases until you have a financial plan that includes your short and long term goals
1. Get professional help managing new wealth
Many individuals experiencing a sudden wealth event didn’t have a financial advisor before the windfall. And if you are working with a professional, ensure they’re equipped to handle your new financial reality.
Professionals to consult for sudden wealth advice
- Sudden wealth management advisor to help with financial planning, managing wealth, and assistance coordinating with the rest of your financial team. At Darrow Wealth Management, we specialize in helping clients manage sudden wealth events. As a fee-only financial advisory firm and full-time fiduciary, we must always act in our clients best interests.
- Tax professional to assist with calculations, tax planning and projections, and filing
- Estate planning attorney to assist with drafting wills, exploring the pros and cons of trusts, and planning for other goals such as providing a legacy for your children, leaving money to family or pets, or charitable goals
Depending on your situation, your advisory team may include other professions too.
Case study
This real example highlights the importance of assembling the right financial team experienced in managing sudden wealth.
In one instance, we flagged shares for a new client as being eligible for a specific tax benefit called qualified small business stock (QSBS) and then connected the client with a tax advisor experienced with Section 1202 to confirm.
In this situation, properly identifying these shares meant the client could sell their stock tax free, an opportunity the client’s former team of advisors seemed poised to miss.
There’s a saying you don’t know what you don’t know. We can’t be experts in everything. But when looking for help managing a windfall, consider engaging advisors who specialize in that thing.
2. Planning for (and minimizing) taxes after a windfall
Taxes should never drive a strategy. But they should always be a key consideration. If you come into money suddenly, it’s important to understand the income tax implications.
Do you have liquidity from selling stock options after an IPO or acquisition?
The tax treatment can be very different in all of these scenarios. And there can be planning opportunities too. This is another reason why it’s so important to work with advisors who specialize in managing financial windfalls.
Taxes after receiving an inheritance
If you received an inheritance, is it in cash, stock, trust, or retirement account?
- If you’ve received an inheritance of a taxable asset (such as a home or investment account) you may qualify for a special tax benefit called a ‘step-up’ in basis
- There are different rules when inheriting a retirement account, which also depend on your relationship to the deceased (parent or spouse). Most inherited retirement accounts will be taxed as regular income (versus the more favorable long-term capital gains rates)
Selling stock in a business
Whether from an IPO, cash buyout, private sale of your company, or merger/acquisition, capital gains and income tax implications vary.
If your newfound wealth is from the sale of your business or result of stock options or equity compensation with your employer following an acquisition or initial public offering.
- As mentioned earlier, consider your eligibility for a potentially tax-free liquidity event with qualified small business stock
- Also weigh the implications of stock sales, stock option exercises, investment risk, and other factors that require planning
- If selling a business, consider the pros and cons of an installment sale to spread the gain over multiple years
Other situations to discuss with your tax professional
- In a divorce, tax planning should be part of the asset division strategy, as the cost basis will follow the asset
- Athletes need to be aware of state tax issues for games played away from their home state
- Proceeds from a lawsuit can be taxable depending on the reason for the payment
- State residency, mobility, and state-specific income tax rules. In Massachusetts, the passing of the ‘millionaires’ tax now adds a 4% surtax to windfalls taxable in the Commonwealth. In some situations, changing your state of residency can yield significant savings
3. Financial planning after a financial windfall
In working with your wealth advisor, you’ll want to consider some of these questions. After receiving a sudden windfall, there are many major financial decisions to make that will have lasting implications.
One-time cash needs
Lay out any one-time potential cash needs. This may be wish-list items or even possible financial moves like paying off debt. Consider mortgages, loans, car or home purchase, people you’d like to help financially, and so on.
This step is crucial as any cash that is used at the beginning can’t be invested for the future, which you’ll need to include in projections.
Ongoing expenses and financial needs
Will sudden wealth change your lifestyle? Do you want to retire? Can you afford to? Quantifying ongoing lifestyle expenses is key to figuring out what’s possible financially in the long-term. Excessive spending, especially at the beginning, can dramatically reduce financial flexibility.
However, as you consider the best ways to utilize sudden wealth, remember that spending drives what’s possible.
Here’s an example:
Assume you receive a $5 million windfall and spend $2 million on a home with cash. You’ll need $500,000 a year for everything else. Using a 6% annual return, you would run out of money in year 8. And that’s before even considering taxes or market volatility!
Now if you spent $1 million on a home instead, and reduced lifestyle expenses to $300,000 per year, the money would (theoretically) last for over 27 years.
The sum of money is the same – but spending drives the outcome.
Sudden wealth advice
What are ways an advisor can help with an unexpected cash windfall? Getting support from a financial advisor specializing in windfalls is key. Here are some examples of ways a wealth advisor may be able to help you manage and invest large windfall:
- Assess financial goals and prioritize or consider trade-offs if needed
- Considering best uses for the proceeds, such as whether or not to pay off debt or put money into investments (or both)
- Stress-testing your plan to help ensure you don’t run out of money
- Considering your legacy goals, charitable giving goals, and the pros and cons of setting up a trust for children or family
- Coordinating with your estate attorney to implement updates across your accounts
- Investing a windfall by determining the right asset allocation and risk-reward tradeoff
- Building an income stream, perhaps with a Treasury ladder
- Considering how to optimize the funding of your financial goals, such as superfunding a 529 plan for your child’s education
These are just a few examples. Depending on your goals and personal financial situation, there may be many more planning opportunities to consider.
Nationally Recognized Sudden Wealth Advisors
Darrow Wealth Management specializes in working with individuals experiencing a windfall or sudden wealth event. Regardless of the source of your newfound liquidity, our advisors can help you build a plan and investment strategy to manage a windfall. As a fee-only financial advisor and fiduciary, we’re always working in the best interest of our clients.
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Publications above reflect media organizations that have quoted and/or published articles authored by Kristin McKenna and should not be misconstrued as a current or past endorsement of Kristin McKenna, Darrow Wealth Management, or any of its advisors. Please refer to the media page for more information and links to published works.
[Last reviewed October 2024]
