It's everyone's dream. Winning the big jackpot that changes everything. But even if you weren't one of the winner's in this week's PowerBall lottery, the issues that come from sudden wealth may still apply to you. In fact, you have many opportunities to experience sudden wealth that have nothing to do with winning the lottery.
At my Orange County financial planning firm, one of the areas in which I specialize is working with sudden wealth recipients. It's always exciting to experience sudden money, even if vicariously. But there are usually significant and unique financial, tax, and emotional issues that, if not addressed, can cause the money to disappear almost as quickly as it was received.
Most of us are used to gradual money, which comes from earning an income and building a nest egg over time. It's a slow and steady process. As our net worth increases over the years, we adapt and slowly become more financially sophisticated. It's like riding a smooth elevator -- you're going up, but you hardly feel it.
Then there's sudden wealth. It's like being on the ground floor of a 60-story building and rocketing to the penthouse suite in seconds. Sudden wealth means getting more money than you're used to being responsible for, and getting it all at once. The most common sources of sudden money are lawsuit judgments, divorces, business sales, inheritances, retirement packages, and stock options.
If you experience sudden money without a plan, you may find that your sudden wealth is suddenly gone. Have you heard of the woman from New Jersey who won two lotteries totaling $5.4 million? She spent it all and now lives in a trailer. What about the entrepreneur who earned $24 million overnight from a successful IPO? Within a few months, he lost it all. What about the man who won $16.2 million? Less than a year later, he was $1 million in debt and now lives on Social Security.
Here are six steps to follow if you want to keep more of your lottery winnings, inheritance, divorce settlement, or lawsuit judgment:
- Build your financial team. While you may be in uncharted waters, you'll want to create a financial team composed of people who live and breathe in these waters. They can help you navigate the numerous tax, financial, legal, and yes, even emotional issues that arise.
- Calculate your "end of the day" number. Your end of day number tells you how much you have to spend, invest, and live off. It's a critical number. Don't buy anything, invest, or make any money decisions until you know this number.
End of the Day Number
(Sudden Wealth + Previous Savings) - (Taxes Due + Total Debt)
Create a wish list. Brainstorm all of the things you want to own and do with the money. Don't hold back. Categorize every item as "Would Like" or "If Possible." "Would Like" items are things that are important to you such as buying a new home, paying for your child's education, and donating to church or charity. "If Possible" items include everything else: travel, gifts to family members, and quitting your job.Determine what is possible. Before you buy that house or car and before you quit your job, you need to determine how far your sudden money will allow you to go. Give your ranked wish list to your accountant or investment advisor to help you calculate what you'll be able to do without getting into financial trouble down the road. If the people who received the sudden money I discussed earlier had taken the time to complete just this step, they wouldn't be broke or in debt today.Go back to school. You don't really have to go back to school (unless you want to!), but you should take some time to get a financial education. Your financial team should explain concepts and strategies so you understand them, but there's no substitute for studying the issues on your own.Monitor your finances. Meet with your investment advisor and/or CPA at least once a quarter (or more often if events in your life have changed). Again, if the sudden money recipients discussed earlier had monitored their financial situation, they'd be in much better financial shape right now.This is an overly simplistic list of things to consider, but it's a great place to start. For more information, you can read the full white paper
: Six Steps for Handling a Windfall.
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