User:Fyre4ce/Managing a windfall

A windfall, in personal finance, is defined as an amount of money that a person gets unexpectedly. Windfalls can range in magnitude from small additions to an individual's wealth to a significant increase in fortune. Since a large windfall almost invariably means huge changes in a recipient's life, psychological and emotional factors are often the most important factors determining outcomes. The National Endowment for Financial Education advises windfall recipients to take the following course of action.

Do nothing rash. Set aside one year's living expenses and place the rest of the windfall into low risk investments (FDIC insured accounts, money market funds, treasury bills) for one year. As it may take as long as five years for the windfall recipient to adjust to a new life, this pause provides a chance for emotions to cool, helps avoid impulsive behavior, and, if warranted, allows the recipient time to put together a team of professional advisers.

Common sources of windfalls
Windfalls come in many forms. Here are some common types:


 * Legal settlements : Settlements include personal injury settlements, settlements involving workers compensation and settlements of employment discrimination. Settlements are taken as either a lump sum or, alternately, as a structured settlement of annuity payments.
 * Inheritances: These can often involve retirement accounts and assets held in trust.
 * Gifts: These can range from annual gift exclusions up to the lifetime estate taxation credit limit.
 * Lottery winnings: Taken as a series of payments; or as the sales value of payments exchanged for a lump sum.
 * Insurance settlements: These can be in the form of death benefits received as either a lump sum or annuity; as pre-death cash surrender values; or as life settlements, the sale of a life insurance policy by the owner to a third party in exchange for a lump sum.
 * Retirement lump sums: Usually taken in lieu of a lifetime series of annuity payments
 * Sudden increases in income: These can come in the form of bonus payments; stock options; or cashing shares in an IPO.

While not being external sources of new wealth, other common sources of receiving large lump sums include the following:
 * A real estate sale
 * The sale of a business
 * Widowhood and divorce

Sales of businesses and real estate involve the conversion of an illiquid asset into large sums of fungible cash. Death and divorce not only cause dislocation and trauma, but often result in suddenly thrusting an individual who has had little or no interest or no experience in investing, into the position of managing family wealth.

Size of a windfall
Windfall sizes vary dramatically. A small windfall might bring you a step closer to your financial goals, a bigger one may make you financially independent, and an enormous windfall might be more money than you ever imagined spending. Windfall size is somewhat relative to your income and assets; what would be a life-changing amount of money for one person might be only accelerate someone else's mortgage payoff by a few years. Some thresholds are more absolute, such as the federal estate tax exemption ($11.58M for singles and $23.16M for married couples as of 2020); financial planners generally agree that additional planning is necessary with assets above this level. This wiki page will focus on larger windfalls that entail significant lifestyle changes and the need for additional planning.

Common pitfalls
Among windfall recipients, common errors of commission include:


 * quitting one's job prematurely
 * buying extravagantly priced automobiles or properties, or engaging in other expensive consumption spending
 * feeling overconfident about one's business or investing acumen, resulting in jumping into new high risk investments (such as hedge funds) or as an "angel" investor in start-up companies
 * falling prey to overcomplicated estate and investment management schemes. Be on the alert for people who may be trying to exploit you or take advantage of your new wealth. It’s important to recognize that you can be a target for all kinds of financial schemes.
 * by being too generous to family, friends, and charities

Common errors of omission include failing to:


 * pay the legally required taxes
 * choose risk-appropriate investments and earn a reasonable return on invested capital
 * utilize appropriate accounts such as retirement plans
 * engage with the right professionals
 * set up the appropriate plans, including estate plans

Preparing
These initial steps will help put you in a position to manage a life-changing amount of money:

Take your time
Finance authorities are in agreement that avoiding immediate impulse decisions is key to prudent management of the windfall situation. Among the recommendations for this period are the following:
 * Tell as few people as possible. Unfortunately, even those close to you may become resentful or solicit you for gifts when they hear about your windfall. You can always tell people later on when you've had time to consider the effect that information may have on your relationships.
 * Set aside six months to one year's worth of expenses in a transaction account such as your checking account. Place the remaining windfall assets in separate accounts holding secure low-risk savings vehicles, such as FDIC guaranteed bank accounts and CDs, money market funds, and treasury bills.
 * Use this period of time to begin resolving emotional, family, and social issues. Different sources of windfall, such as the death of a loved one, may have powerful emotional consequences that you should focus on addressing, while spending minimal time worrying about finances. Coming to terms with your emotions will allow you to make better financial decisions.
 * Hire a competent and unbiased tax professional, such as Certified Public Accountant (CPA), if you don't already have one. Estimated taxes may need to be filed. Complex tax issues may surround distributions from retirement plans, inheritances, and lottery winnings, as well as the exercise of stock options. If you're not sure if your windfall has tax consequences, many tax professionals will be willing to give you a free consultation. Prefer someone who doesn't sell investment products.
 * Consider paying off any high-interest debts, and getting current on debts on which you are delinquent. The goal isn't to begin putting your money to work, but rather to reduce stress and distractions. Only make the minimum payments that will allow you to focus on the future, and don't redirect payments to paid-off debts to more spending.

Think about goals
Begin to think about long term goals, with more focus on the life you would like to create and (for now) less focus about how to achieve it. Some ideas for goals that may be meaningful:


 * Retiring, either in the short or long term
 * Changing jobs
 * Starting a business
 * Going back to school, either to pursue a new career or just for enjoyment
 * Saving money for benefit of a loved one (529 plan for education, trust fund, etc.)
 * Moving to another city, or country
 * Paying off debts
 * Certain consumer purchases
 * Purchasing real estate
 * Traveling
 * Taking up a new hobby
 * Growing your family
 * Donating to charity
 * Volunteering your time

Most likely, your windfall will not be enough to fully fund all or even most of your goals, even if the windfall is large, so it's important to prioritize your goals. Many financial novices are surprised how little of a windfall they are actually able to spend immediately. For example, a $1M windfall will only generate about $30-40,000 per year of investment income over the long run, so initial spending will need to be limited so the windfall can provide a lasting improvement in lifestyle. Specific goals, and allocation of money toward them, will be formalized later in a written financial plan.

Get educated
Like it or not, you now have a new job (in addition to any other jobs you may already have) - learning how to manage money. Whether or not you are inclined to "do-it-yourself", you will need at least the knowledge necessary to evaluate financial professionals. Educating yourself on personal finance and investing will likely be, by far, the most money you will ever "earn" per hour, if it makes the difference between lifelong prosperity and a fortune squandered within a few years.


 * Read some recommended books on personal finance and investing. Reading at least three, that cover the topics of personal finance and investing, would be a good start.
 * Browse the rest of the Bogleheads wiki. Many pages are meant to be accessible to those with little or no investing experience.

Get help
Unless you are already an experienced investor, it may be beneficial to hire a professional to help you manage your money. Should you decide to use an adviser, the authors of The Bogleheads' Guide to Investing (Chapter 16, p.193: Wiley. ISBN 978-0471730330) recommend choosing an adviser who has earned a CFA (Chartered Financial Analyst) or a CFP (Chartered Financial Planner) designation; uses a fee-only payment arrangement; and advocates an index fund investing approach. The fee-only compensation structure minimizes the advisor's conflicts of interest with respect to your financial success. A good financial advisor should be able to do the following:


 * Calculate whether it is better to receive a lump sum or annuity stream of payments from a settlement, lottery winning, or retirement package
 * Strategize about how to minimize taxes owed
 * Recommend an investment strategy
 * Recommend any additional types of insurance you may need, or what current types of insurance you hold may no longer be needed
 * Determine whether you need to enlist an estate planning attorney;

A CPA with a Personal Finance Specialist (PFS) designation may be able to perform some or all of these functions too, in addition to preparing your taxes. To avoid conflicts of interest, it is advisable to select a CPA (PFS) who does not sell financial products and does not accept compensation from the other professionals the CPA may recommend. The American Institute of Certified Public Accountants has a website where one can search for a CPA (PFS) in your locale: Find a CPA

You can get free portfolio reviews and answers to personal finance questions on the Bogleheads forums. Most forum members are not finance professionals, but are nonetheless experienced investors, and as a whole have managed an enormous range of income and assets.

Formulate a plan
Financial planning is a long-term process of managing your finances so you can achieve your goals and dreams, while at the same time negotiating the financial barriers that inevitably arise in every stage of life.

The steps necessary for implementing the inclusion of a windfall into a financial plan will be affected by the windfall recipient's age and investment knowledge as well as the size of the windfall relative to the recipient's current wealth. An individual with an established financial plan and investment portfolio, upon receiving, for example, a profit-sharing bonus, might simply invest the bonus into the investment portfolio. For life-changing windfalls, and situations involving inexperienced investors, the step by step process of establishing a financial plan can help the individual to rationally meet goals.

Here are the steps you should consider taking as you develop and implement a financial plan:


 * Establish goals. The initial and most important step is identifying objectives (in a family, agreeing on shared objectives), e.g., buying a house, retiring early, ensuring that children get an excellent education, and so on. Determining what the objectives are, and when you would like to meet them, is primary. See also: Investment Policy Statement
 * Divide your goals according to when you want them realized. Rank each goal within each time frame in order of importance:


 * 1) Short-term goals you want completed in one year;
 * 2) Intermediate goals to be completed in the next five years;
 * 3) Long-term goals.


 * Evaluate your financial status. Carefully include the windfall into your financial situation, net worth, and budget, and insurance planning. Supposing that retirement is one major goal, see if your new wealth provides for an adequate income (using a withdrawal rate of 3% to 4%) that would allow you to live off your capital. If this is not feasible, your new wealth can be invested towards a future retirement.
 * Among the prudent steps one can implement during this stage is to pay off high interest credit card debt and establish an emergency fund.


 * Investing your capital. The investment strategy you adopt will be defined by the time horizon of your goals. Investment authorities commonly advise investors with goals coming due within five years to restrict investments to short-term instruments such as bank CDs, money market funds, and short-term treasury securities that all mature by the time the funds are needed.


 * For long-term investments, the key decisions will involve what asset classes should be selected; in what proportions (asset allocation); and how these should be adjusted over time. Since many asset classes can rise and fall in value, you must understand your need, willingness, and ability to take investment risk. See implement the plan for further details.


 * Investment Policy Statement: Once you have made your investment decisions these should be formalized in an Investment policy statement (IPS) or Investment plan.


 * Execute needed estate planning documents. You may need to create an Estate plan. Commonly this will require the establishment of wills, powers of attorney, and trusts. Estate planning also includes any planned giving you wish to make.


 * Monitor the plan & make necessary adjustments. Once a year, reevaluate your goals and compare to your time horizon. Adjust your insurance, estate matters, and rebalance your investment portfolio.