Sudden wealth can come from various sources, such as an inheritance, the sale of a business, winning the lottery, or an IPO. Each type of windfall has its own set of planning considerations. For example, the tax implications and distribution terms for an inheritance are different from those for an IPO. Managing sudden wealth, especially when received as cash, requires careful planning, although it might be less complex initially.
Experiencing a sudden increase in wealth is rare, often occurring only once in a lifetime, if at all. This makes proper financial management crucial. Sudden wealth is when a person’s financial situation changes drastically, often unexpectedly. This can happen in various ways:
– Many who come into sudden wealth didn’t have a financial advisor beforehand. If you already work with a professional, ensure they can handle your new financial reality.
– At Darrow Wealth Management, we specialize in managing sudden wealth events. Depending on the nature of the windfall, working with a specialist is essential.
– For instance, we identified that a new client’s shares qualified for a tax benefit called qualified small business stock (QSBS). We connected them with a CPA familiar with Section 1202, allowing them to sell their shares tax-free. Their previous advisors lacked expertise in stock options and sudden wealth, prompting the change.
It’s true that you don’t know what you don’t know, and nobody can be an expert in everything. When seeking help for sudden wealth, consider advisors who specialize in this area.
Market volatility and liquidity issues can pose significant challenges. For example, in 2021, many founders and executives with stock options experienced sudden wealth when their companies went public. However, some watched their paper profits diminish before they could sell their shares. Others didn’t diversify due to optimism, taxes, or other reasons, and with the market downturn in 2022, some companies went bankrupt. The IPO market also froze, leaving those who had changed their financial situation in anticipation of liquidity events in a difficult position.
Business owners should avoid spending proceeds until deals close, and professional athletes should be cautious as their contracts might not be guaranteed. Until a future windfall is received, earned, or diversified, your financial situation might not actually change much. The proceeds could end up being worth much more or less than anticipated.
Taxes should always be a key consideration, though they shouldn’t drive your strategy. Before making any irreversible decisions, discuss the tax implications with your advisors. The tax treatment of sudden wealth can be complex. For example:
– Non-retirement asset beneficiaries might benefit from a step-up in basis, allowing them to sell without a taxable gain, though the estate itself might be taxable.
– In a divorce, tax considerations should be part of asset division, as the cost basis follows the asset.
– Athletes need to be aware of state tax issues.
– Lawsuit proceeds can be taxable depending on the reason for the payment.
– In Massachusetts, a new millionaire’s tax adds a 4% surtax to windfalls. Evaluating planning strategies to reduce tax is worthwhile, such as spreading the gain over multiple years when selling a business.
Coming into a large sum of money can tempt you to splurge, but it’s a major mistake. Consider delaying significant spending or gifting until you have a solid plan and understand liquidity constraints. For example, trust fund beneficiaries might not have immediate access to funds. Assessing the feasibility of your goals and priorities, along with tax implications, is crucial. Discussing your desires with a sudden wealth advisor can help determine if the windfall is sufficient to meet your objectives. If not, explore trade-offs or alternatives.
This article is an introduction, as there are many other considerations for those expecting sudden wealth. These include gifting strategies, charitable goals, diversification, investment approaches, trust and estate planning, and asset protection. These complex issues should be addressed with a team of legal, tax, and financial professionals.
Your planning needs will depend on the nature of your windfall and your overall financial situation. Darrow Wealth Management is a fee-only advisory firm specializing in sudden wealth events. By integrating financial planning with investment management, we aim to help you build and grow your wealth. Learn more about our Wealth Management Services and how we can assist you.