How to Keep Your Cool (and Your Money) When You Get a Financial Windfall

There are several ways to get rich suddenly—and even more ways to squander your money and end up poor.

Almost anyone who gets a large windfall can fall prey to “sudden wealth syndrome.” The recipient can fall into the trap of believing their newfound wealth will never run out and they can buy everything and do anything.

Some people who get an inheritance, sign a big contract, get a stock payout or win a settlement buy huge houses and boats and go on spending sprees. Some invest heavily in risky ventures or faltering businesses owned by friends or family members.

But it’s not all recklessness. Buying a big house with the proceeds of, say, a large divorce settlement may seem like a reasonable choice. But property taxes, upkeep, and remodeling can tie up a lot of your income. This can be hard to undo later on if you don’t have enough cash to meet your day-to-day expenses or save for retirement.

How can you prevent a windfall from turning into a curse?

Have a plan and a budget so you’ll know what you can and can’t afford. And hire qualified advisors to help implement it. Plan before you make large purchases, not after.

First, assemble a team of professionals. One of these should be a fee-based Certified Financial Planner. Get a clear understanding about the fees you will be charged to ensure the planner is putting your best interests ahead of his own.

You may also want to consider adding an accountant or tax expert and a wealth manager, depending on what services your primary adviser offers. An estate-planning attorney will also be helpful.

Researching and vetting these professionals takes time, but it’s crucial.

Next, plan for taxes. While inheritances, life insurance proceeds, and divorce settlements typically are not taxable, most other windfalls are. Your financial adviser or accountant will be able to tell you how much tax you’ll owe and when it will be due.

Set aside any money you’ll need to cover state and federal taxes before doing anything else.

Next, pay off any outstanding bad debt right away. Bad debt, such as credit-card debt, is debt to buy something that immediately decreases in value. It usually carries a high interest rate.

Good debt creates value. Education loans, business loans and mortgages can produce long-term wealth and may also offer tax breaks. Work with your financial adviser to get a more complete picture of what repayment schedule makes the most sense for good debts.

Create a budget to ensure your annual expenses don’t exceed income unless you’re retired. Even if you’re retired, you’ll still want to avoid invading principal too quickly and running out of money.

Your budget should be flexible because that makes it more likely you will actually stick to it over time. Set a budget too rigidly, and you run the risk of abandoning it altogether. A budget you ignore is useless.

Your budget should allow for any large near-term purchases, such as a home, a vehicle or a vacation. By including such big-ticket items in your budget, you can evaluate the implications before you buy. This will allow you the confidence to move forward with an understanding of any adjustments or trade-offs the purchase may require.

Your budget will also help with your next planning step: creating a long-term investment strategy. Consider funding your retirement, paying for a child’s education or future support, perhaps starting your own business, and supporting charitable causes.

It’s tempting to use new money to invest in exotic investments, but a well-diversified portfolio adjusted for your risk tolerance is the best way to secure your financial goals.

Finally, your estate-planning professional will help you ensure that the wealth you worked hard to preserve and grow will pass to your intended beneficiaries upon your death.

At a minimum, you should update your will — or create one, if necessary. Depending on your situation, you may want to consider more complex planning techniques, such as creating trusts or reconfiguring insurance arrangements.

Shomari Hearn, Certified Financial Planner (CFP) and vice president, Palisades Hudson Financial Group, is based in its Fort Lauderdale, Florida, office. Palisades Hudson is a fee-only financial planning firm and investment manager based in Scarsdale, NY, with $1.2 billion under management. Branch offices are in Atlanta, Fort Lauderdale, FL., and Portland, OR.Read Palisades Hudson’s daily column on personal finance, economics and other topics at http://palisadeshudson.com/current-commentary. Twitter: @palisadeshudson.