The Smart Way to Manage a Windfall | Charles Schwab

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The Smart Way to Manage a Windfall

February 19, 2015

You’ve probably spent some time imagining a lottery win or some other influx of wealth. What you likely haven’t dwelt upon: the practical steps you’d need to take if you actually had an enormous infusion of cash.

After all, anything from an inheritance, the sale of a business, a company going public, a major bonus—or even the sale of a property—can bring you a life-changing amount of money. But it’s unlikely that a windfall would buy you the freedom to stop thinking about your finances. In fact, the opposite is true, says Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research.

“The wise management of a windfall requires a total, comprehensive financial overhaul,” he says. In order to plan with a clear head, first hit pause. You don’t want to compromise your newfound wealth with impulse buys or gifts you might regret. So put the cash someplace stable, such as a money-market account, for at least three months. That gives you time to assemble a team of professionals who can help you work through financial matters.

Financial Windfall Management

Figure out the tax implications

There’s no such thing as a free lunch—or a tax-free lunch, either. Chances are you will need to pay taxes on your newfound cash. The question is, How much?

  • While inheritances and other gifts generally escape federal income taxes, funds from other sources such as the sale of short-term property, lottery winnings or a legal settlement may be taxed as ordinary income at up to a 39.6% federal rate.
  • Other income, such as the sale of a business, real estate or stocks, may be taxed at the lower long-term capital gains rate.
  • Equity compensation, including proceeds from an initial public offering, may be taxed as ordinary income, or receive favorable tax treatment, depending on how it’s structured.
  • You may owe additional state taxes as well; these vary depending on the state and your circumstances.

Whatever the case may be, it’s crucial to figure out the applicable taxes far in advance of tax time. “Consider that money already spent,” Rande says. Get an estimate of the damage from your CPA, then set aside that money in a relatively safe place such as a bank account or money market account. Depending on the circumstances, you also may be responsible for paying estimated taxes for the year in which you receive the windfall.

Re-think your asset allocation

If you’re in your 40s or 50s, you’ve likely shaped your portfolio around the need for growth to build wealth. Post-windfall, however, you may want to structure your holdings around wealth preservation to buffer against severe drops in the market. That might mean moving from an all or mostly stock portfolio to one that emphasizes fixed income holdings.

You may also want to explore strategies such as investing in municipal bonds, which can help reduce future tax bills if you find yourself in a higher tax bracket going forward. “It makes sense not to take any more risk than you have to,” Rande says. “Once you’ve got it made, you don’t want to lose it.”

Update your giving strategy

Want to let others share in your good fortune? This is an opportune time to indulge your spirit of generosity, but you’ll want to revisit (or create) your gift and estate plan to make sure you’re giving smartly.

A donor-advised fund, for example, allows you to gift a large chunk of assets to qualified charities, and reap an immediate tax benefit. You can then decide how you want to allocate the donated money over time.

Alternatively, a private foundation offers more flexibility in how the money is managed and donated, but also requires more paperwork. Speak to your estate planning attorney about the pros and cons of these and other charitable vehicles, as well as the best way to make gifts to family members or other individuals, if you’re so inclined.

Re-assess insurance needs

The purpose of life insurance is to support your family should you pass away during your working years; however, if you’ve got plenty in the bank now, you may no longer need to pay those premiums. Should you buy a nicer car or home thanks to your windfall, you’ll also want to review and update your property and casualty policy.

Finally, consider an extra layer of protection: Your newfound assets could make you a financial target in the event of a lawsuit, notes Rande. An extra liability policy, known as an umbrella policy, covers personal liabilities above the typical limits on home and auto insurance policies.

Be smart about debt

Ditching costly consumer debt (such as credit card debt) is a no-brainer. You may also want to repay student loans that offer little tax benefit. You may even be tempted to wipe out your mortgage. “People tend to associate paying off the mortgage with financial freedom,” says Patricia Seaman, senior director at the nonprofit National Endowment for Financial Education. But that may not be the best financial move, particularly if you’ve refinanced during the recent stretch of ultra-low interest rates.

A primary home loan at a 3.5% rate is equivalent to about 2.3% after taxes if your combined federal and state income tax bracket is 35% and you’re able to deduct all the interest expense. There’s a good chance you could get a higher rate of return by investing the money elsewhere. That said, don’t forget about risk. Paying off a loan is the same as earning a risk-free return equal to the cost of the money, Rande notes.

Once you’ve taken care of the practicalities you can think about how the money might help you fund important life and career goals—a project you want to launch, for example, or the chance to explore a new direction for your retirement. Those may be the true luxuries that a windfall affords.


Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment, legal, or tax advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Fixed income investments are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, corporate events, tax ramifications and other factors. For further details, please contact a Schwab fixed-income specialist.

Income from municipals and tax-free bonds may be subject to the Alternative Minimum Tax (AMT), and capital appreciation from discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

The investment and tax strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment or tax strategy for his or her own particular situation before making any decision. Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Schwab Charitable does not provide specific individualized legal or tax advice. Please consult a qualified legal or tax advisor where such advice is necessary or appropriate.

Schwab Charitable is the name used for the combined programs and services of Schwab Charitable Fund, an independent nonprofit organization, and Schwab Charitable Trust Services, a limited liability company owned by Schwab Charitable Fund. The Fund has entered into service agreements with certain affiliates of the Charles Schwab Corporation.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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