Sudden wealth can take many forms, including selling a business, executing stock options or reaching a legal settlement. Most often, however, sudden wealth is the result of an inheritance. About one-third of U.S. households expect to receive an inheritance, according to the U.S. Bureau of Labor Statistics, and each year from now until 2050, between $1 trillion and $3 trillion will be transferred to heirs, according to a study by Accenture.
Receiving a large inheritance, especially when tied to the death of a parent or loved one, can trigger powerful and conflicting emotions that may lead to risky financial decision making. In fact, research from The Ohio State University found that one in three people who received an inheritance lost all of their savings within two years.
A trusted financial advisor can provide stability and insight to help individuals navigate these complicated and confusing times. In addition, there are different strategies individuals can employ to avoid five of the pitfalls that oftentimes accompany sudden windfalls.
Pitfall #1 – Hasty decision making
No matter the source of the windfall, financial inheritances trigger visceral emotional responses to this sudden change in circumstance.
The best course of action to take after a windfall is to do nothing – at least for a while. Taking the time to take a step back is encouraged. By taking a moment to find clarity, it allows you to figure out your priorities and create a plan. Determine what decisions you have to make in the short-term, like tax planning and settling an estate, and what decisions you can wait to make, such as how to maximize the impact of your newfound wealth.
When the time comes to begin planning for more long-term initiatives, it is important to think in board strokes about the legacy you want to create with these newfound assets. Often, individuals wish to honor their families’ values after receiving inheritances. For example, if the deceased loved one placed a particularly high priority on education, one way to preserve that legacy is to establish a trust to fund college tuition for future generations, or to endow a scholarship in the person’s memory.
Pitfall #2 – Losing perspective
During the initial period of reflection, it is important to maintain perspective. Individuals may feel like their newfound wealth weighs them down with considerable expectations and a responsibility to the deceased family member. They may think about this new sum of money differently than their other assets. This can affect their decisions about how to spend or invest it.
For example, some people may feel pressured to distribute virtually all of the money among the rest of the family or to only use it for philanthropic causes. Feelings of guilt might accompany the receipt of this money, which makes them vulnerable to opportunistic family members and others. This stress can cause irresponsible or unsustainable spending as inheritors work through these feelings.
Pitfall #3 – Withholding information
A windfall can prompt people to be more close-lipped about their finances. Some feel uncomfortable about their new wealth, others feel isolated from their former peers, and still others are wary of those seeking handouts.
This instinct to withhold information often extends to your financial advisor as well. However, during every big transition, especially sudden wealth, it is critical to provide your advisor with a full picture of your financial situation. Your advisor will serve as a partner to assist you through the decision-making process and help you to spot issues before they become problems.
Pitfall #4 – Failing to update plans
After receiving a financial windfall, it is crucial to review the financial planning framework you previously had in place. Estate plans virtually always require a revisit and revamp, along with insurance policies.
Wescott helps clients navigate updates to estate plans driven by considerable windfalls. Many clients use this opportunity to increase their support of charitable organizations or even to give to a cause that has become important due to the passing of a loved one, whether research of a disease that he or she suffered from or an organization where he or she volunteered . While some of these decisions, such as major philanthropic ventures, can be finalized over time, it is very important to review your current beneficiaries and insurance needs soon after receiving an inheritance.
Pitfall #5 – Being caught off guard
While the exact timing of many windfalls is unknown, the eventuality of many inheritances , especially from parents, might be expected. To be as prepared as possible, start by assembling your team – a financial advisor, a lawyer and an accountant. Your trusted financial advisor can lead this team to create a plan for your future that provides for various contingencies while staying true to your priorities and goals as your financial situation changes.
If you do find yourself caught off guard by a financial windfall, reach out to a financial advisor who has a strong background in helping individuals navigate times of transition. He or she will help ensure that you avoid common pitfalls and will partner with you to work toward your financial goals.
Talk to a Wescott advisor today about creating a long-term plan for your finances.
