Financial Advisor in Raleigh NC: Financial Windfall
While the odds of winning the lottery may be slim, there are other financial windfalls that occur more frequently. Life insurance payouts, generous family gifts and inheritances are just a few. With a sudden influx of assets, it's crucial to be cautious.
Taxes and Other Potential Costs
Not all windfall funds are entirely yours to keep. When it comes to proceeds from business sales and bonuses, expect to pay state and federal income taxes. While life insurance payouts, gifts, and inheritances are generally exempt from federal and state income taxes, certain states impose inheritance taxes of up to 16%.
In the case of inheriting a 401(k) or traditional IRA, you may need to withdraw the entire account within a specified timeframe, typically 10 years, unless you qualify for exceptions such as being a surviving spouse. These distributions will be taxed as ordinary income. However, stocks and bonds held in a brokerage account typically receive a step-up in cost basis upon the former owner's death. This means that if you sell them immediately, you will likely not owe capital gains tax.
When it comes to inheriting real estate, it's important to carefully consider your options. Selling the property may incur capital gains taxes based on the difference between its inherited value and the sale price. However, if you choose to keep the property, such as for use as a vacation home or for future gifting to your children, be aware of additional expenses like property taxes, insurance, upkeep, and travel costs if it's located far away.
If you plan to offset expenses by renting the property, realistically assess how much rental income would cover your costs.
Prioritizing your Goals
Once you have determined the post-tax amount of your windfall, it's time to update your net worth statement and create a cash flow projection. Begin by prioritizing replenishing your emergency fund and paying off any high-interest debt. Then, you can assess which long-term savings goals to prioritize. Consider how much you should allocate towards retirement or college savings, and if your improved cash flow allows for increased contributions to 401(k) or IRA accounts.
If a portion of your windfall consists of stocks and bonds, you'll need to decide which holdings to sell or retain, considering how they complement your existing portfolio. This may also prompt a review of your overall investment strategy. For instance, if you currently have an aggressive allocation geared towards wealth accumulation, you might consider scaling it back to focus on capital preservation.
Alternatively, the additional assets could present an opportunity to take on additional risk, particularly if you intend to pass them on to future generations. A financial professional can offer suggestions for how you might shift your strategy to help meet your long-term financial goals.
Your Giving Strategy
It's important to be prepared for potential financial requests from family and friends following your windfall. While you may have the desire to share your good fortune, it's crucial to have a well-thought-out strategy regarding the amount you can afford and are willing to give, as well as the recipients. In 2023, you can gift up to $17,000 per year to an individual without it counting towards your lifetime gift tax exclusion. Couples can gift up to $34,000.
Additional gifts beyond these limits will utilize your lifetime gift exclusion amount, which is $12.92 million in 2023, and may require filing a federal gift tax return. However, there is an exception with 529 plans, allowing you to front-load five years' worth of gifts and contribute a lump sum of up to $85,000 ($170,000 for couples), known as accelerated gifting.
A gift can also be used to assist family members in achieving their financial goals. For instance, parents in the San Francisco area helped their adult children purchase a house that would otherwise be unaffordable. Additionally, you might consider using your windfall to support charitable organizations that hold personal significance.
Donor-advised funds offer a viable option, providing an immediate tax deduction and the ability to make annual gifts in the future. Consult with a tax attorney or financial professional to explore tax-efficient avenues for fulfilling your charitable objectives.
Revisit your Estate Plan
Whenever there is a change in your financial circumstances, it is essential to reassess your estate plan. This involves reviewing and potentially updating your core estate documents such as your will, revocable trust, and power of attorney, as well as examining the beneficiaries listed on your life insurance or retirement plans.
Evaluate who is designated to manage your finances if you become incapacitated or pass away, and consider if you wish to modify how your assets will be distributed after your death. You may also want to include other family members, friends, or charitable organizations in your estate plan whom you may not have previously considered.
While a financial windfall can have a positive impact on your life, it is important to be aware of potential pitfalls. Take a moment to pause and reflect upon receiving the windfall, make deliberate decisions, and establish a long-term plan for investing, spending, and potentially gifting. By doing so, you can ensure that this stroke of luck not only brings immediate happiness and financial stability but also secures your well-being for the years to come.
Bottom Line
A financial windfall can provide a significant boost to your finances, but it's important to approach it with thoughtfulness and careful planning. Start by taking a moment to consider the implications and avoid impulsive decisions. Assess your financial situation, set clear goals, and seek professional advice if needed. Be mindful of taxes and potential obligations that may come with the windfall.
By approaching a financial windfall with caution, thoughtful planning, and professional guidance, you can make the most of your good fortune and set a solid foundation for your financial future.
Sources:
https://www.nerdwallet.com/article/finance/sudden-money-financial-windfall
https://www.kiplinger.com/personal-finance/605158/what-to-do-with-a-windfall
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