Windfall Planning: What to Do If You End Up With a Million Dollars

Baby boomers are expected to inherit several trillion dollars over the next decade. Whether the windfall comes from inheritance, winning a lawsuit, divorce, a retirement lump sum, nearly every facet of your life will change. Careful planning is necessary to avoid pitfalls like lavish spending, scam artists, and greedy relatives. 

In fact the first thing to do upon receipt of a windfall is NOTHING. While you will be anxious to go shopping or put your money to work, resist the temptation to quickly spread it around. Instead, place the funds in a money market mutual fund or treasury bills, where it can earn a safe guaranteed return until you have your other planning tasks in order.

Before you make any investments, make major purchases, or pass out gifts, you first need a comprehensive plan. Find a financial planner who has experience in comprehensive planning and charges by the hour without a product to sell. The plan must cover every facet of your financial life, including:

• Retirement planning
• Insurance
• Credit management
• Income tax planning
• Investment Planning
• Gifting
• Estate planning

While you may feel that you no longer have to be concerned with retirement planning due to your windfall, nothing could be further from the truth. It’s more important than ever to produce a budget.  Admittedly, it will be much more generous than the one to which you have been accustomed. But, without the plan, squandering and excessive gifting is far too likely. 

Your financial planner will be able to guide you, providing you with a questionnaire to establish your desired future lifestyle. She can prepare a long-term cash flow analysis to assure that you are able to sustain your lifestyle without depletion of your funds. Gifting to relatives may be an important part of your planning and should be included, as well as sufficient recreation. The purchase of a new, more expensive home may be appropriate and can be included in the long-term analysis. Remember, a home is an asset and should be included in your overall asset allocation.

While your life insurance policy may no longer be necessary, comprehensive liability coverage is now needed. This is also known as umbrella insurance, and provides protection from lawsuits, with limits exceeding those on your homeowner’s and auto policies. The amount of your windfall can be your guide in establishing the amount of umbrella insurance needed.

If your windfall has tax liability associated with it, the financial planner can advise you as to the proper amount to reserve for payment of income taxes. If you received property as a gift, the tax basis is carried over to you. Thus, capital gains taxes may be due upon sale.

While you should definitely pay off all credit card and high interest loans, certain debts may have advantages. For instance, the loan on your home provides an interest deduction for purposes of calculating income taxes. 

You also need to review your will, or have one drawn. The executor you have chosen may not be able to manage a million dollars. You may wish to leave money to children or grandchildren in trusts in order to provide for asset protection and provide guidelines for withdrawals. Your financial planner will be able to provide you with a referral to an estate attorney.

When you have these affairs in order, consider how to invest your windfall. I recommend doing so over a period of two years. In this manner, you reduce the risk of buying at the top of the market or when interest rates are unfavorable. 

Assuming that the appropriate asset classes are stock mutual funds, government or corporate bonds, real estate, and cash equivalents, this chart outlines my recommendations for allocation for a 50 year-old person who is still working, but wants some extra income:

    
Investment Category            Now                         Within next 12 months           From 12 to 24 Months
Cash & Equivalent                  100% of windfall      30% of windfall                        10% of windfall
Stock                                       0                              25% of windfall                        50% of windfall
Fixed Income                           0                              25% of windfall                        30% of windfall
Real Estate                              0                              20% of windfall                        10% of windfall

Needless to say, your age, health, family status, and need for income will all come into play in the allocation. As a general guideline, the younger you are, the more you should allocate to stocks. The older you are, the more you should invest in bonds. If you plan to withdraw large sums in the near future, increase your allocation to cash and equivalents. Your financial planner can assist you in establishing the proper allocation for your individual situation. The final allocation assumes paying $100,000 down on a home, and keeping $400,000 in fixed income (bonds) and cash equivalents to provide about $20,000 in income each year. Fifty percent of the windfall goes into a diversified portfolio of stocks (such as you find in mutual funds or exchange traded funds) to ensure your assets have a chance to appreciate in value.

While this article is not intended to teach you the intricacies of investing, the following tips will serve to provide basic guidelines:

* Create a plan before you act, determining the proper asset allocation.
* Don’t invest in anything you don’t understand.
* Don’t put too much in any one investment: diversify.
* Invest no more than 5% in one stock
* Remember, there is no sure thing when it comes to investments in stocks.
* Avoid purchasing anything offered to you via the Internet or over the phone.

While receiving a windfall is enviable, there is a lot of pressure that comes with it. Through a written financial plan addressing every facet of your financial life you can enjoy your windfall, while seeing that the money is properly managed and protected. In this manner, your children will some day also have the challenge of managing a windfall.