Let’s say you win one year’s salary in a contest (or by picking the right Community Chest card), and you don’t want to end up like one of those lottery winners who went bankrupt.
This doesn’t have to be you. With the right strategy, you can turn your winnings into a meaningful part of your future rather than hazy Atlantic City memories. Financial planners are in fervent agreement on how to make it happen. It all starts with…
1. Do nothing
“The first thing they should do is nothing. The second thing they should do is take a deep breath. And the third thing they should do is nothing again,” says David Mendels, a planner with Creative Financial Concepts and president of the Financial Planning Association of New York. “It really is the single biggest problem people have with it. They go, ‘Whoopee! I got all this money! Now I’ve got to do something!’ That’s when they start making mistakes.”
All the planners I spoke to were adamant on this point: when you receive a large sum of money, it causes temporary brain damage. No matter how frugal you were before, a fresh wad of found money can turn you into the kind of person who tries to clean out Amazon.com. “The first thing to do is nothing,” says Kirk Kinder of Picket Fence Financial. “Don’t buy anything. Don’t talk about your windfall to others.”
How long should the cooling-off period last? Until you’ve cooled off and the money isn’t so exciting anymore. The most common recommendation is six months. “Put the money in a short-term vehicle like a money market, CD, or Treasury bill,” says Kinder. A six-month CD would be perfect.
2. Think about taxes
During the six-month vacation from your money, figure out how much of it belongs to you and how much to the IRS.
“If it’s any kind of contest winnings,” says Mendels, “you want to take the tax implications into account and make sure you don’t get a nasty surprise come April 15, when you have to pay tax on money that’s somehow already gone.”
This would be a perfect time to make an appointment with a tax professional such as a CPA or enrolled agent.
A year’s salary is a tricky amount of money to come into. It’s enough to make a big dent in almost anything you feel like denting, but not nearly so much that you can scratch everything off your bucket list.
“For some people it might mean the ability to buy a car,” says Mendels. “For somebody else it might mean the ability to help a friend or family member. To another person it might be funding for college for my kid. For another person it might mean being able to get out from under the credit card debt.” Sit down, make a list of possibilities on paper, and see what rises to the top.
For most people, the best uses of a windfall are the most boring:
- -Establish an emergency fund
- -Pay off debts, including the mortgage
- -Max out retirement accounts
- -Donate to charity
- -Save for college
This kind of dull move offers you financial flexibility. “It may be boring, but there are worse things than being boring,” says Mendels. Besides, now you’ve shored up a foundation that allows for guilt-free hedonistic self-indulgence down the road.
What about the common advice that you should spend a portion of the windfall immediately on something fun? Rob Oliver, a certified financial planner in Ann Arbor, isn’t so sure. “Most advisers recommend spending a portion of the money to get the need out of your system,” he says, “but most people go overboard.”
4. Beware of friends in need
A windfall can strain your relationships with family and friends. There is no easy way to tell a sibling that, no, even though you won a contest, you can’t lend them money. Of course, giving money to someone in need might be a satisfying use of your winnings—after the cooling-off period.
So, to sum up: protect yourself from your cash-addled brain and from requests for largesse; sit on the cash for a while; don’t forget Uncle Sam; and then make a boring move. It’s not flashy, but I bet it’ll turn out better than that time you won second place in a beauty contest.
** If you’re interested in learning how to achieve financial success and get insights from Certified Financial Planners, sign up for the Financial Planning Association of New York’s Ninth Annual Financial Fitness Workshop in New York City on October 1, 2011.