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How to Manage a Windfall

Coming into a large sum of money (whether from an inheritance, a gift or a legal settlement) is a good thing, but it can also have its down sides. A study of Florida lottery winners found that more than five percent of winners declared bankruptcy within five years. Managing a windfall responsibly — with discipline, thoughtfulness, and planning — is critical to achieving your long-term goals.

If you have come into a large sum of money, consider these guidelines:

Wait. Most financial planners advise waiting six months to a year before you do anything with your windfall. During that period, keep the money in a safe place that allows you easy access (such as a money market fund or online bank savings account). You will not earn much interest, but you will give yourself time to come up with a solid plan for how to use the money. If a loved one left you an inheritance, this will also give you time to grieve before you make any big decisions. Waiting also helps moderate the desire to spend impulsively.

Assemble your financial team. If you are unaccustomed to dealing with a large amount of money, you will need to put together a group of advisers to help you get the most from your good fortune. Your team should include a financial planner and a certified public accountant. Depending on circumstances, you may also need assistance from a lawyer and an insurance professional.

Determine the tax obligations. Some windfalls are tax free; however, the government takes a cut of some windfalls, such as lottery winnings and certain legal settlements. A large estate could be subject to federal and state estate taxes. An inherited trust or inherited IRA could also lead to tax burdens. To the extent the windfall pushes you into the top income tax bracket, you could lose 39.6% — or more — to federal income tax.

Form a plan. Consider where you would like to be five, 10 or 20 years into the future. Develop a budget that will help you move toward your goals — whether that means retiring early, starting a business, or something else.

Pay off debt and boost savings. Paying down debt can provide a higher return than many other investments, especially if it is high-interest-rate debt and the interest is not deductible, such as that on credit cards. Establishing or boosting your savings minimizes the need to incur future debt.

Keep working. Few windfalls are large enough to see anyone through to retirement or death. Until you have a solid handle on the amount available after taxes and debt and have identified solid financial goals, you will not know if you can quit your job. Once you quit your job, remember that you will stop earning income that contributes to your Social Security retirement benefits — which you may need if your investments turn sour.

Be careful when asked for money. Friends and family members may expect to share in your bounty, and charitable organizations may ask for donations. The ability to support worthwhile causes or loved ones in need is a real benefit of a windfall. At the same time, if you accede to every request, you will quickly deplete the funds.

Have some fun. It is OK to splurge a little and spend a small portion (one to two percent) of your windfall on something you enjoy. However, you do not want to blow the entire amount on frivolous items that neither offer lasting satisfaction nor provide a sound foundation for the future.

A windfall can be a blessing, but managing one wisely takes discipline, thoughtfulness, and planning. The attorneys at MendenFreiman can provide advice that will enhance your financial security and help achieve your goals. Contact us today if you have any questions.

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