Many of us dream of the chance of a financial windfall in our future. From the sale of a property or business to an inheritance or an unexpected influx of cash, do you know how you'd handle that opportunity?
"The No. 1 mistake we see is not planning ahead of the windfall," says Anna Howard, Senior Vice President and Senior Wealth Planning Manager for Wells Fargo Private Bank's California region. "Clients sometimes think it's not relevant to discuss a potential windfall until it materializes. Once a client has received the funds, they lose out on the option of using a number of powerful planning strategies."
Here, Howard outlines steps you can take to help prepare for a financial windfall.
Evaluate your goals
As soon as you receive news of a potential financial windfall, it's time to evaluate how it may affect your overall wealth plan and whether you may now have some new goals to incorporate. "Is this money that you will likely spend during your lifetime and for what purpose?" says Howard.
Everyone is going to have different wealth goals, but popular options include setting aside funds for education for kids or grandkids; buying a second home; giving to charity; covering medical expenses or saving for future ones; investing your financial windfall; or making annual exclusion gifts.
As soon as you receive news of a potential financial windfall, it's time to evaluate how it may affect your overall wealth plan and whether you may now have some new goals to incorporate.
Howard stresses that as you weigh your financial windfall options, keep in mind tax strategies and the importance of timing. "It takes some time to work through implementing some charitable and estate planning strategies, so the sooner we know what is going on, the more likely there will be a beneficial outcome for the client."
Charitable giving, for example, must be carefully timed to help maximize income tax efficiency. And new opportunities and tax liability reductions with estate transfer open up when beneficiaries have advance knowledge of an inheritance.
Strategize your financial windfall scenarios
Your wealth strategy will also depend on what type of windfall you receive, as each one has its own set of parameters. Your wealth planner or advisor can help guide you.
Howard breaks down a few guidelines and considerations for common types of windfalls.
- Selling a house. "If it's your primary residence, where will you move?" says Howard. "After considering income tax consequences and replacement costs, what's remaining? If it's an investment property, will you exchange into a replacement investment property or realize the tax consequences?" One of Howard's clients, for example, wanted to mitigate a large gain on the potential sale of a primary residence. It made sense for him to move out and convert the home to a rental property for a few years and then sell so he could use a 1031 exchange and reinvest in more real estate without losing capital to income taxes.
- Inheriting money or other assets. "Many of our clients have significant wealth themselves and expect to inherit some assets when their parents or another relative passes," Howard explains. "In this case, it may make the most sense to inherit assets in an ongoing irrevocable trust." This structure enables you to utilize the inherited assets to the extent that they are needed and then pass the remainder of the trust holdings on to your beneficiaries with potential tax advantages.
- Selling a business. Consider how you might replace the income coming from the business. Also, do you need the funds from the sale to start another business, to retire, or a little of both? There are also a number of strategies to be considered in an effort to mitigate income tax with a business sale, so professional advice is recommended.
- Winning the lottery. While your odds of winning the lottery may be miniscule, people who win are faced with a significant decision that must be made quickly. "There are typically payout options when winning a lottery," says Howard. "Both financial and tax planners should be involved in this process before an option is decided."