How to Manage a Windfall

May 7, 2023 Scott Hiller
Three tips for incorporating a large influx of assets into your financial plan.

What would you do if you suddenly came into a life-changing amount of money? It may sound like a dream come true, but such a payout can prove complicated if not managed wisely. To paraphrase the Roman philosopher Seneca: A great fortune can be a great servitude.

Even those who've spent their lives building a successful business to sell for a substantial gain can be caught off guard by the emotional and financial ramifications of a big influx of assets.

With that in mind, here are three tips for managing such a payout—with an eye toward the future.

1. Reassess your goals

Depending on the size of the windfall, some of your goals—such as saving for a child's education or amassing a substantial nest egg—might feel less urgent than they once did, but that doesn't mean you should deprioritize them. It's wise to work with a financial planner who can help you take stock of your new financial reality and adjust your plan accordingly.

Next, consider how you'd like to put your payout to work. If your hope is to reinvest some of the capital in a new venture, for example, be sure to stash that money in a stable, liquid investment—such as an interest-bearing certificate of deposit—that won't lose value while you sort out your plans. Or, if your goal is to grow your wealth in the stock market, consider working with an investment advisor who can help balance long-term appreciation with wealth preservation.

2. Plan for taxes

Depending on the form the payout takes, you could face a significant tax bill—or potentially none at all.

Proceeds from the sale of a business, for example, are taxed at short- or long-term capital gains rates, which can be as much as 40.8% for those in the highest tax bracket. However, if you sold qualified small business stock (QSBS) and you held the shares for at least five years, you may be able to exclude 50% of any gains from your tax liability. If you didn't hold the assets that long, you may be able to defer taxes by reinvesting the gains in a new qualified business within 60 days.

If your wealth comes in the form of company stock, you might be on the hook for two forms of tax: ordinary income tax at the time the shares vest and capital gains tax when you sell the shares. The taxation of equity compensation ultimately depends on the type of stock award you receive, so consider consulting a tax specialist who can help you strategize the best way to liquidate your holdings.

In the case of an inheritance, even after any estate and/or inheritance taxes are settled, you could still owe taxes at some point in the future if the bequest came in the form of:

  • Investments, including real estate: The value of the inherited investment generally resets to the current market value at the time of death,1 but any future gains on the asset will be taxed at the prevailing capital gains rates at the time of the sale. For example, if you inherit shares of a stock worth $500,000 at the time of the decedent's death and you sell them for $600,000 two years later, you'll owe long-term capital gains taxes on the $100,000 gain.
  • Retirement assets: Nonspouse heirs who inherit a tax-deferred retirement account, such as a 401(k) or an IRA, may have to take annual required minimum distributions (RMDs)2 and generally are required to liquidate the account within 10 years,3 paying ordinary income tax on the withdrawals. Inherited Roth IRAs, too, must be depleted within a decade and may be subject to annual RMDs,4 but heirs will not owe any tax on the withdrawals.

Tax laws are often in flux, so it's wise to work with a tax expert who can help you find the right strategies and set enough money aside for tax time as well as assist you in determining if annual RMDs apply to your particular situation.

3. Protect your legacy

Finally, be sure your estate plan reflects your new financial situation. Whatever your goals—from creating a generational wealth plan to leaving a charitable legacy—a financial planner can assist you in fine-tuning your strategy to help preserve your expanded wealth for years to come.

1If the decedent resided in a separate property state, their sole property, plus 50% of any jointly owned property, will receive a step-up in basis. Community property states, on the other hand, do not have a consistent treatment for the cost basis of inherited assets. Consult a tax advisor for more information.

2If the original account owner had reached their RMD age, then non-spouse heirs will be subject to annual RMDs under the 10-year distribution rule.

3An heir may be exempt from the 10-year distribution rule if they are the minor child of the account owner, 10 or fewer years younger than the account owner, or disabled or chronically ill as defined by the IRS.

4As of publication, the IRS has not provided definitive guidance as to whether or not inherited Roth accounts covered by the 10-year rule are subject to annual RMDs.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment 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.

Investing involves risks, including loss of principal.

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

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