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Your Investing Life: Managing financial windfalls

April 21, 2014

We've all had dreams about receiving a financial windfall. Maybe you've imagined winning the lottery, selling a successful business, or getting an inheritance from an unknown benefactor. You’ve probably also imagined how that windfall could improve your life. If that windfall is now real, there are a few things you'll want to consider to help keep your dream of long-term financial health real too.

Take time out if you can

You usually don't have to make any big moves the minute you get your money. (However, if you have urgent financial obligations, such as loan defaults, use your windfall to take care of them as quickly as you can.)

Sarah Hammer"Sometimes, financial problems can arise when you feel the urge to splurge immediately after receiving your newfound wealth," said Vanguard Investment Strategy Group's Sarah Hammer. "Purchasing lavish gifts, taking expensive vacations, and buying an exotic and trendy new financial investment can be a bad idea. Instead, consider placing your money someplace reliable, like a money market fund, and take some time to plan your next financial step."

Decide what you want to do with your windfall

Picture how you'd like your life to look in five, ten, and maybe even 20 or 30 years. Where are you living? Are you retired? Traveling the world? Still working, but with less financial stress? Are family members, loved ones, or friends with you? Jot down your visions so you can keep that picture clear.

Kevin Wick"Setting some goals drives your decisions about how to invest your windfall. With a direction in mind, you can plan more effectively," said Kevin Wick, a senior wealth planner with Vanguard Asset Management Services™.

Ask for guidance from an expert you trust

Consider working with a financial expert to develop a plan that uses your assets to help you accomplish your goals. The key is to find a good match. You want the right type of professional for your situation, whether it's an attorney, a Certified Financial Planner®, or a tax expert. Depending on the size or complexity of your windfall, you may even need a team of experts.

You also want to have confidence in the person who's advising you. "Do some due diligence. Seek out endorsements from people whose judgment you trust. Confirm they have good standings with their respective professional organizations. Then meet with each recommended expert to determine which one inspires your confidence," Mr. Wick said.

Invest for your future

You may feel like your windfall will always be there, especially if it's substantial. But it can disappear more quickly than you think. The National Endowment for Financial Education noted in a study that an estimated 70% of people who suddenly received a large sum of money will lose it in about seven years.

Mary RyanThat's why it's important to invest at least some of your money for your future, whether you work with a professional or independently. "You want to make sure that this money will last through your lifetime—and perhaps even further to pass to your heirs," said Mary Ryan, a financial planner with Vanguard Asset Management Services.

Mr. Wick advocates for thinking long term as well. "Avoid looking for the quick fix, which, more often than not, leads to a quick downfall," he cautions.

You want to match the asset allocation—your mix of stock holdings that can have more risk associated with them, bond holdings that are generally more predictable, and cash holdings that have essentially no risk—to the goal you want to achieve. You can divide how you invest your windfall to fund multiple goals. For example, the portion you devote to supporting your lifestyle for a retirement 20 years from now may have a higher risk profile than the portion to fund a high school student's college education, which you'll need to use much sooner.

Consider Vanguard's principles for investing success, which focus on four simple elements you can control—having clear goals, developing a suitable allocation of broadly diversified mutual funds, keeping investing costs low, and maintaining a long-term perspective.

Prepare to pay taxes

Depending on the type of assets you received, you may have to turn over a share to Uncle Sam in the form of taxes. You can usually inherit taxable investment accounts or payouts from an insurance policy without paying federal taxes, although some states do have inheritance taxes. However, inherited IRAs and annuities have tax implications.

Other types of windfalls are also taxable. Examples include severance package payouts, bonuses from your employer, proceeds from the sale of your business, and game show or raffle winnings—even if they're not in cash. You may need to sell the asset or property that's not liquid in order to pay the taxes on it.

Check out our online Tax Center and consider seeking help from an accountant, tax professional, or trusted advisor. This way you won't get taken by surprise by any tax bills.

Share your wealth wisely

Spreading your newfound wealth through gifts to family members and friends is wonderful when done wisely. You're more likely to get requests for these gifts. It can be difficult to balance your desire to be generous with your need to be practical about giving financial gifts. Gifts of property and money can be subject to federal gift taxes. However, there are some exceptions, including:

  • Giving any number of people up to $14,000 each per year ($28,000 if you're married). These gifts are called annual exclusion gifts.
  • Paying any amount toward another person's tuition or medical expenses, as long as you pay these amounts directly to the school or medical provider.
  • Giving any amount to your spouse. (Special rules apply if your spouse isn't a U.S. citizen.)
  • Making a gift to a qualified charity. (There are some restrictions, as detailed on irs.gov.)

Supporting a cause or organization you care about is a great way to make a difference with your windfall—and get some tax benefits, too. You have a number of charitable giving options available, all with their advantages—and things to consider.

If you find yourself beset by donation requests from many worthy causes, a donor-advised fund, which allows you to contribute and invest assets and then grant them to charities at a future date, may be an option worth exploring.

Ann Gill"A windfall may afford you the opportunity to give a substantial gift to charity for the first time," said Ann Gill, chief philanthropic officer at Vanguard Charitable. "Before you give, take time to consider what you want to achieve with your philanthropy and set some goals. Not only will you be better prepared to respond to solicitations from charities, you can also feel confident your donations will make a difference."

Develop an estate plan to protect your loved ones' futures

An estate plan is nothing more than pieces you put together to provide for those you love when you're no longer here. The concept may seem a bit intimidating, but with a little information and help from a qualified expert, it can help you accomplish your long-term goals and give you great peace of mind. The beginning pieces of a good plan include:

  • A will.
  • Medical power of attorney.
  • Advance directive (living will).
  • Agent authorization for financial accounts.

It may make sense for you to establish a trust—or several—for you and your loved ones. You don't have to be uber-wealthy to set up or use a trust. It's simply a way for you to set parameters around how the assets you put into it are distributed. One example includes planning for minor children or grandchildren.

"A properly designed trust can ensure that a child or grandchild is not receiving a large inheritance at age 18. The trust can protect that inheritance until the child reaches what is considered to be a more appropriate age, be it 21, 30, or 50," Mr. Wick said. A qualified estate planning attorney can help you create a trust that fits your particular situation.

Enjoy a splurge

Now for the best part: Allow yourself a splurge! Maybe it's traveling to a place you've dreamed of seeing or buying a nice car or vacation retreat. "Give yourself the freedom to enjoy your windfall—in moderation," Mr. Wick said. By taking the steps suggested here, you'll be better prepared to enjoy your money for a long time to come.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • We recommend that you consult a tax or financial advisor about your individual situation.
  • An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
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