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Financial Windfall Through Inheritance
Sep 01, 2020
Receiving a financial windfall through a large inheritance sounds like a dream, right? It certainly can be, with the proper approach and planning. Without that, however, the dream may quickly become a nightmare.
Most people are not prepared for the tremendous amount of emotional stress, complexities of financial management and the changing dynamics of personal relationships that sudden wealth often brings.
An enormous range of conflicting emotions can overwhelm those who suddenly acquire wealth, including numbness, fear, isolation, exuberance, unworthiness, resentment, uncertainty, shock, grief, guilt and indifference.
Unaddressed, these feelings can lead to Sudden Wealth Syndrome, a psychological condition, in which the overwhelming pressures of unexpected and / or abrupt fortune can develop into emotional and behavioral afflictions.
If you act before you are prepared, you are likely to make some regrettable mistakes. Gifting is a perfect example. If you immediately start giving money away without understanding the long-term implications for your goals, you may find your money slipping away quickly and your goals unmet.
Taking a careful, well-ordered approach will help you to avoid falling into the trap of making decisions before you are ready.
Most financial and estate planning experts recommend a three-phased approach.
Phase One – Decision Free Zone
In Phase One, your focus is solely on planning
and preparing
for investment and lifestyle changes you will make. Instead of making quick, rash decisions, this is a time to prepare
to make decisions. During this phase, keeping emotions in check and preparing for financial planning are priorities.
Stay calm, refrain from emotion-based decisions and resist the influence of others. Don’t give up control. As tempting as it might be to hand over control, especially while dealing with emotions, keep in mind this is your money and your future that is at stake.
In fact, it’s probably best at this phase not to share news of your sudden wealth in order to avoid any pressure to make financial promises to family and friends.
The first decision you should make is determining who will be on your “Dream Team.” In selecting your team, choose people who have your best interest in mind (for example, a Financial Advisor who is a Fiduciary). With the right team in place, you’ll maximize the likelihood of having your money last as long as possible.
As you build your team, start learning more about investing and financial management (if this is new for you). Most people take decades to accumulate a nest egg, building financial literacy skills steadily along the way. People receiving a sudden windfall don’t have that opportunity, so developing your financial literacy skills should be a strong focus for you and your team.
Your team should comprise the following:
1.CPA
A CPA will serve as your tax advisor and can identify the tax implications associated with your inheritance.
Many beneficiaries view their inheritance as “free money,” failing to recognize the tax implications and how a large tax bill can chip away at the inheritance.
For example, if you have inherited an Individual Retirement Account (IRA), you could lose a large portion of the money if you do not follow the complex rules that apply to inherited IRAs.
Working with your CPA, you will be able to determine exactly how much tax you owe. When you know the amount, it’s a good idea to put it into a separate account and not touch it until the tax payment is due.
2. Estate Planning Attorney
You’ll want to draft an estate plan that adequately protects your assets, minimizes future taxes, ensures that your assets are distributed according to your wishes, and avoids probate.
Your estate attorney can assist you in updating (or creating) your will and drafting a power of attorney which designates who would make decisions about your affairs if you were unable to act on your own.
3. Financial Advisor
A sudden windfall immediately moves you from a position of accumulation of wealth (building a nest egg) to management of wealth. Your goals will probably change, as well as your tax bracket. This makes it important to find the right financial advisor.
It’s important to identify your “end of day” number. This is the amount you have available to spend, invest, and gift after other obligations (taxes due and any debt you wish to eliminate) are met. Your financial advisor can help you determine this number. Even small inheritances offer an opportunity to ease some burdens and fulfill some dreams, if deployed wisely.
Your Financial Advisor will be critical in Phases Two and Three.
These three (CPA, Estate Planning Attorney, Financial Advisor) are the most essential members of your team, but there may be others as well. Given that you have more to lose now, you’ll likely want to increase insurance coverages and take out an umbrella policy to further protect yourself. An insurance agent can be another vital member of your team.
If real estate is a part of your inheritance, you may also consider adding a trusted realtor to your team.
Don’t rush the process, if the amount you are receiving is enough to make major changes in your lifestyle, this phase could take more than a year. Except for determining tax liability, all other decisions can wait.
Phase Two – Putting Your Money to Work in Investments
Losing an inheritance is easy. So, it’s imperative that you have skilled financial professionals to guide you through the process and help you make the most of your windfall. One study found that most adults who receive an inheritance save half (or less), while spending, donating or losing the rest.
What choices does this inheritance now open up for you? What goals do you want to accomplish? Consider creating a Wish List of all the things you want, whether feasible or not. Next step will be to refine the list based on the financial reality of each item.
Take your Wish List to your financial advisor. Based upon your goals and risk tolerance, they can help select appropriate investments that will support your financial plan. In thinking through your investment plan, be mindful that imprudent investing and investment scams are one of the greatest pitfalls for those receiving an inheritance windfall. Be especially wary of any investment that guarantees returns, promises quick profits, has unusually high returns, or is presented with heavy pressure to invest immediately. The adage “if it sounds too good to be true, it probably is” rings true here.
A financial advisor can help define your risk tolerance. At Optima, we use a psychometric questionnaire to help us determine the three elements of your risk profile: your need to take risk, your ability to take risk, and your willingness to take risk.
Life expectancy, return on investment and inflation will all affect the longevity of your inheritance.
Phase Three - Monitoring and Sharing
This phase will last the remainder of your life, and possibly beyond.
In this phase, you may realize that you have enough money and income for your own needs and begin to think about passing your wealth on to your loved ones and sharing with some charitable causes.
Working with your CPA and Financial Advisor, you can create meaningful impact with charitable giving, as well as enjoy significant tax benefits, if you do it strategically.
You will want to monitor your plan regularly with your Financial Advisor and CPA. Your financial plan will change, and this is expected, but you need to be sure you stay on track. This could mean meeting with your CPA and Financial Advisor at least once a quarter (at least initially).
Develop a system of checks and balances whereby you make a commitment to your financial team that you’ll consult with them on purchases that exceed a certain amount. You’re not asking permission – after all this is your
money – you are simply doing everything possible to ensure that you make wise decisions with your money.
Sadly, 70% of inheritances do not survive through second generations. However, with proper planning and an understanding of potential pitfalls, receiving an inheritance can provide you and your family with sustained financial security.