Episode 32: How to Handle a Sudden Wealth Event
Sep 26, 2022
On this episode, Isaac Wright, CFP®, ChFC® and Kevin Buenvenida, CFP®, share some tips on how you can navigate a sudden wealth event from an inheritance or a lottery winning. In addition, Isaac and Kevin discuss the things you should consider to avoid common investing and tax mistakes.
Here are just a handful of the things that we'll discuss:
- Cash flow challenges
- Assets and debt
- Insurance planning
- Tax planning
- Long-term planning
- Protecting your privacy
Isaac Wright: Well, good day and welcome back to Wright Money Tips. For this month, we’re really going to focus on a conversation that would be, in a lot of respects, a positive conversation. We would want to make sure you stay positive with what we’re about to say, which is inheriting a lump sum of money, or in other words, having money come to you as a windfall and really how to prepare yourself with the decisions that surround that all of a sudden you get notification that, “Hey, you got some money coming your way. We’re not talking about one or two bucks.”
So, I think this is going to be a great talk today. Kevin Buenvenida, is one of our lead advisors here at Financial Dynamics. And we have over the years Kevin, talked to quite a few people that have had everything from a lottery winning, of course inheritance is always the biggest thing. But I think more importantly, is no matter what you define as a windfall, something that could be life changing for you. Whatever that amount is, you want to make sure, including of an inheritance, that you’re making a good decision when it really comes down to how to handle that money. Because if it’s not handled correctly, you may wind up having a lot less of it.
Kevin Buenvenida: That’s right.
Isaac Wright: So, Kevin, let’s maybe start with defining a little bit that windfall, that inheritance, of course we can talk about cash flow, expenses, things that you’d want to pay attention to. Where would you like to start today? Because really, I thought this would be a great opportunity for you to kind of show your knowledge base.
Kevin Buenvenida: Yeah, absolutely. I think the biggest part here is identifying what it is that you’re actually receiving. You know, through an inheritance or some sort of financial windfall, through let’s say an estate transfer process, you got one or two buckets to work with.
You might have an asset that’s considered to be illiquid: real estate, shares in a small business from a family member that you have received. And there are going to be costs associated with you either maintaining that asset, or maybe as you divest down the road based on your needs, turning that asset into cash.
The other bucket might be straight up cash, an investment account, a 401(k) or traditional IRA. And in those situations as well, you want to make sure that what you own in each of these respective accounts, the costs and fees associated with that. And again, how do you convert it to cash if you have an immediate need for liquidity or just basically want to hold onto the money?
Isaac Wright: So, what I’m hearing you say first and foremost, this is probably good for all of you to listen to. But first and foremost is understand the asset class that you are inheriting and get familiar with some of the rules. Don’t go out and just immediately sell something or run rough shot over that asset.
You definitely want to understand the background of what you’re owning to make a better decision relative to again, taxes, how much you’re going to be able to net from the result of whatever you inherit. I think it’s a great thing to say, and again, for all of you listening, if you don’t have a situation where you have somebody that’s helping you with the potential of having either this inheritance come your way or a windfall, that’s something we hear at our firm. We can easily help you with that and make sure that you make good decisions around that particular inheritance or investment.
Kevin Buenvenida: Absolutely. And kind of sticking on that note about taxes. Let’s assume you get that traditional IRA inherited and you’re not what we consider to be or what the IRS says as an eligible designated beneficiary. They changed the rules back in 2019. Previous to the rule change, you could extend out that life of the individual retirement account by taking small chunks of a required minimum distribution each year. That rule has been basically wiped out. And if you’re not in eligible designated beneficiary, you’ve got 10 years to basically deplete the account with RMDs along the way.
What that really means is as an individual, as you take money out, you get hit with taxes at your ordinary income tax rate. So that might be something you want to know ahead of time, especially if you’re going to be or in a fortunate position where you’re a high-income earner. And maybe that additional required minimum distribution coming in puts you up into a different tax bracket.
Isaac Wright: Yeah. I was going to say, especially, most people today will wind up inheriting some level of tax deferred retirement money and there’s a whole subset of rules. I know we’re not going to have the time to go into all of that, but the detail that Kevin just covered is basically knowing that you have to take that money out over a period of time. And if you don’t do that correctly, there are penalties and fees, not only above just the tax situation. It can be a significant amount of money that you wind up otherwise not planning for correctly that’s coming out of your pocket per se.
Kevin Buenvenida: That’s right.
Isaac Wright: Let me switch gears a little bit. You know, again, we’re sitting here talking about inheritance money and so forth, but somebody can win a large amount in a lottery. You have payouts, you can take a lump sum. You know, I think we do also have some of the things that we can do here from a software standpoint to run some analysis of whether or not to take it as a lump sum or as a payout.
And again, without going into all the weeds, I think a lot of you understand that if you do get into a large pension buyout, or if you get into an annuity payment, or an annuity that you win through a lottery, that’s something we can analyze as well.
Kevin Buenvenida: Yeah. And I think as you talk about large cash inflow coming in and understand maybe the tax impact of what that might look like, but also weighing out the benefits of how to properly structure a payment for your long-term goals.
Make sure you’re doing that in tandem with identifying which of your long-term goals might look like. If this windfall is going to adjust, accelerator, maybe even delay time horizons to certain events of your life. And make sure that the efficiencies are there so that again, you’re not surprised on the backend. Things that you weren’t considering or didn’t know which you didn’t know upfront.
Isaac Wright: Well, let’s keep it going, man. What else do you want to talk about when it comes to this from a standpoint of just call it day to day affairs?
Kevin Buenvenida: So, let’s assume that’s a good chunk of change that you’re inheriting or winning from a lottery. You know, the number one thing is assume that there’s going to be some semblance of tax. And from a cash flow perspective and maybe heading off a future, headache, is to consider maybe setting aside what that tax liability might look like. When it comes to day to day, month to month cash flows, you know, if you’re not one that’s tracking spending, maybe this is a good opportunity to identify how much you’re spending today. Because you might be presented with an opportunity to leverage this one fall by getting rid of some high interest credit card debt, paying off or paying down student loans or mortgages. But the bigger impact is knowing what you’re spending today because this windfall might actually affect or increase your spending in the future.
It would be a shame to see the effects of this one fall be diminished because you circled right back to the credit card after paying it off. Or didn’t know that the mortgage that you had was probably not in line with what your long-term financial health really should be.
Isaac Wright: In other words, it’s easy to kind of fall back into old habits. And you know, sometimes, you know, if you’re not disciplined enough, you could take that windfall and wind up spending it. And of course, we hear all the horror stories with people that have had the lottery winnings and they not only go broke, but they’re in an even worse position than they were before the lottery because they didn’t know how to handle it.
You know, on a positive note, windfalls handled correctly could very well mean that you could retire sooner. Or the definition of your retirement may mean that you can change your lifestyle to allow you to have more hours during the week, to be able to do things other than sit in front of a computer or desk or whatever your work is.
So, I think without being overly negative, I think it’s just making sure that you’re due diligent with the windfall that you have. Again, whether it’s a sale of a business, whether it’s a buyout, whether it’s an annuity, life insurance, any of this money that comes to you through an inheritance, or lottery winnings, any of this stuff. I mean, I’ll just put this in the big umbrella of, “Hey, it’s a large amount of money coming your way.” You want to do things right with it.
Kevin Buenvenida: Absolutely. And you think about maybe one efficiency on that note about life insurance. Let’s assume you pay off some of that outstanding debt, the mortgage, and maybe you currently carry a life insurance policy. That sole purpose was that if something bad happens to you and you want to make sure you take care of your family, that life insurance death benefit covers any outstanding liabilities.
If you take that financial windfall responsibly and pay off those debts, you may not need that life insurance policy anymore where that’s free cash flow on a month-to-month basis or creates an efficiency for another tax-free benefit to your loved ones. If you were going to keep or maintain that policy, but obviously that’s all obtainable in a bigger picture comprehensive financial planning type of conversation.
Isaac Wright: Well, listen, let’s wrap up here. I think people understand the concept of, “Hey, listen, if somebody has a situation where they get a large amount of money, they know where to reach us at. They know what to kind of maybe look for a little bit here. Any closing thoughts around it?
Kevin Buenvenida: I think being diligent and mindful about your windfall is probably the best way to keep yourself in the right mindset to protect yourself in the future. And we’ve seen it plenty of times, just make sure that you know what you’re getting into.
Isaac Wright: Yeah. So again, you know, think about what we’ve said today. We’ve seen a lot of employers now doing lump sum buyouts of pensions. Again, the definition of what we’re covering today is having a windfall, which is a large sum of money coming your way. And sometimes that’s not necessarily covered in the way that we covered it today, which is some of the pros and cons around how to handle that from a tax and from a logistics standpoint.
So, we want to thank you for listening in today. We always want to thank you for listening to Wright Money Tips and we’ll talk to you soon.
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Advisory services offered through J.W. Cole Advisors, Inc. (“JWCA”). Financial Dynamics & Associates, Inc. and JWCA are unaffiliated entities.
Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.