What to do with a Windfall

Wondering what to do with a windfall? Perhaps you have received an inheritance or have sudden wealth from company stock. Now you need to know how to use the proceeds to maximize the benefits and work to achieve your lifestyle goals. Ultimately, how to invest a windfall will depend on a number of factors, including your risk tolerance, time horizon, and spending plans.

The Tax Treatment of a Financial Windfall

Windfalls can come in many forms so it is important to understand the exact details of yours. If you’ve received an inheritance, is it in cash? Stock option sales? Property? Inheriting a retirement account like a traditional IRA is treated differently than other types of accounts for tax purposes. Although there are exceptions, life insurance proceeds received in a lump sum aren’t typically taxable. Review our overview of how an inheritance may be taxed for more information.

If your windfall is from the sale of a business or proceeds from a large liquidation of stock (which typically happens after a trigger event such as an IPO, merger, or acquisition), it is equally important to understand the tax treatment of the funds. In these types of events, there usually isn’t any automatic withholding (or it’s not enough), so it is important to work with your tax advisor to estimate the tax and make quarterly payments.

Once you have a better idea of the taxation of your windfall you can estimate the proceeds you’ll have available after tax.

We specialize in working with individuals experiencing a sudden wealth event, typically from stock options or selling a business. To discuss your situation and how we may be able to help you maximize the benefits of a windfall, schedule a phone consultation today.

Stress testing a financial plan

Sudden Wealth Financial AdvisorHow to Invest a Windfall

Figuring out the best way to invest a sudden wealth starts with financial analysis and thoughtful consideration of your goals. For many of us, our lifestyle goals are not in short supply. Having options for extra cash is a good problem to have. The challenge then becomes prioritizing wants and needs to arrive at the best plan for you.

Without developing a comprehensive financial model, it’s difficult to evaluate multiple scenarios, trade-offs, and opportunity costs over the long term.

It’s tempting to spend a financial windfall on a home or lifestyle upgrades. However, as you consider the best ways to utilize sudden wealth, remember that spending drives what’s possible financially.

For example, assume you receive a $5 million dollar windfall, buy a $2M home with cash, and withdraw $500,000 annually to meet expenses. Assuming a 6% annual return, you’ll run out of money in year 8 – before even accounting for taxes or market volatility. If, instead, you bought a $1M home and took out $300,000 per year, the money would theoretically last for over 27 years. The sudden wealth is the same – but spending drives the outcome.

When we develop a financial plan for our clients, we combine all the pieces of their financial and life situation to create one cohesive view. Using income, fixed expenses and other discretionary spending data, we are able to project clients’ after-tax cash flows to help determine the financial possibilities.

Throughout the analysis, a windfall can be allocated to different 3 broad goal-based categories: spending, investing, and saving.

Think of spending as many different types of short-term cash outflows such as buying a home or other real property, large charitable contributions, or perhaps paying off debt. Investing is for longer term goals, at least five years away, and may include retirement or college planning. Saving is primarily used when current cash reserves are insufficient and properly funding an emergency fund is advisable.

Now recall the different types of windfalls discussed at the beginning of this article. Depending on the type of liquidity event, the funds may not be available at once, or there can be limitations or a penalty for when and how the proceeds are used. Timing plays a key role in financial modeling, as does taxation.

Prepaying Your Mortgage is Probably a Mistake

Unless you have just won the lottery, your recent windfall may not be enough to fully fund all of your goals. Through modeling, we can help you evaluate trade-offs within the assumptions of the plan. Instead of just winging it, a financial model can help provide the information you need to make more deliberate financial decisions for you and your family.

Sudden Wealth Advisors

Whether you’ve received an inheritance, sold a business, or have sudden wealth from the sale of stock options, our advisors can help you build a financial 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.

Schedule Phone Consultation

Sign Up for Weekly Investing Insights