Sudden Wealth – Dream Come True or Nightmare?

Who wouldn’t want to receive a large inheritance, win the lottery, or sell a business for millions? People receive sudden wealth for many reasons, but an inheritance from a family member is the most common scenario we encounter. It’s important to recognize that an inheritance often comes with deep grief and loss, in addition to the burden of learning how to manage unexpected financial resources. Though it can be hard to imagine a financial windfall being anything but helpful, for many, sudden, unexpected wealth ends up closer to a nightmare than a dream.

Let’s start with a few statistics.

• 70% of wealthy families lose their wealth by the second generation and 90% lose it by the third generation.
• Only half of inheritances are saved and 30% of recipients have spent it all within two years.
• Lottery winners are more likely to go bankrupt within 3 to 5 years than the average American.
• 78% of NFL players and 60% of NBA players go broke within 5 years of retirement and are 7.8 times more likely to file for bankruptcy than the average American.

Talk with recipients and you’ll also find that sudden wealth, especially inherited or from sale of a business, often causes strife in marriages and other close relationships. My wife and I have counseled hundreds of couples and seen this play out time and again.

Why does this happen? Because money with nowhere to go…goes somewhere. Let’s look at a few common mistakes and how to avoid them.

Common sudden wealth mistakes.

Here are a few of the most common mistakes we see when receiving sudden wealth.

1. Quick, extravagant lifestyle spending. Large homes, expensive cars, and fancy jewelry all make the list of common purchases. But once the money is gone, these luxuries still need to be maintained, insured, repaired, kept up. If your lifestyle exceeds your living, trouble is sure to follow.
2. Reactive gifts or loans to family and friends. People come out of the woodwork at the news of sudden wealth asking for loans, gifts, support. Should you be generous? Absolutely! Just not without a plan – you’re not an ATM.
3. Hasty investment decisions. Many feel that since they didn’t have the wealth to begin with, why not swing for the fences? Go all in on that tech IPO or perhaps a friend’s promising business. If it doesn’t work out, you’re back where you started. If it does…jackpot! Often, the risk of substantial loss or investment terms aren’t thoroughly understood.
4. Doing nothing. While some make decisions too quickly, others are paralyzed by all the options and end up holding their windfall in cash for long periods of time, missing out on years of valuable compounding interest.

I received sudden wealth…what should I do?

Despite these statistics and common mistakes, you can avoid these pitfalls and put your sudden wealth wealth to work. Here’s how.

• Slow down. Especially if your wealth came as a result of a death in the family, take the time you need to grieve and process the emotional stress that can come with this kind of loss. It can be wise to get your financial bearings and learn who you need to talk to when it comes to making decisions, but consider a cooling off period and wait to make major decisions until you’ve had time to plan properly.
• Don’t go it alone. Build a professional team to guide you, commonly including a Certified Financial Planner, Certified Public Accountant, and estate planning attorney. Not sure how to interview them? Use our guide to interviewing a financial planner!
• Make a plan. Purchases, investments, and gifts should all align to your big picture goals. Your professional team should explain how your sudden wealth can impact your retirement, college for your kids, debt repayment, and any other important objectives. They can also help you prioritize the funds.
• Avoid tax traps. Cashing out certain inherited assets like IRAs comes with significant tax consequences. Often, you will have to pay full income tax rates on every dollar you withdraw, leading to unexpected tax bills. You could also face steep penalties for missing RMDs, or required minimum distributions, which come with strict deadlines.
• Leave values and vision, not just wealth, to your family. We call this a Legacy Plan. Money is easy to lose, but values stand the test of time. If you invest time into teaching future generations about the long-term impact they can have on loved ones and causes they care about, they are far more likely to care about stewarding your wealth well.
• Plan your gifts. Generosity is a virtue! Consider in advance who you want to support and how much of your sudden wealth you’ll dedicate to people and causes you care about. Planning to give allows you to give more sustainably and feel better about it.
• Start now. When’s the best time to plan? The answer is always now! You can start today by building healthy habits. Practice living within your means today and sudden wealth will feel more like a gift than a life raft. Discuss how you might use an inheritance if you received it. What goals might you accomplish, and gifts might you give? If you’ve considered how to use sudden wealth ahead of time, it won’t be so unexpected when you receive it.

So, is sudden wealth a dream or a nightmare? It all depends…have you planned for it? A financial planning and wealth management team like ours here at Alterra can help you weigh these important decisions, avoid common pitfalls, and give you the clarity you need to feel confident in your plan. Reach out for an initial discussion!