Rags to Riches: Managing a Windfall

At some point in your life you may experience a stroke of good fortune and be the recipient of a financial windfall. A windfall could be anything from winning the lottery to receiving a sizable year-end bonus. Receiving an inheritance, selling your home (if downsizing), getting a large tax refund, and gifts are more examples of windfalls.

This sudden influx of cash also comes with great responsibility. After the windfall, your next steps are pivotal in determining the trajectory of your future financial security.

Susan Bradley, founder of Sudden Money Institute, is a highly acclaimed certified financial planner who specializes in managing windfalls and personal financial transition planning. Following along with her work, I have compiled a list of things to keep in mind when you are the recipient of a windfall. Whether it is a $20Million lottery winning or a $100,000 inheritance, you need to be equipped with effective strategies to not only manage your finances, but your emotions, as well.


Take a step back and breathe.

Depending on the event that provided you with your newfound income, you’re likely experiencing a wide range of different emotions. If it was through an inheritance, you likely have feelings of sadness associated with the windfall. If you won the lottery, you may feel overwhelmed, excited, and in disbelief. Further, studies have shown that many people who become recipients of large amounts of money, report experiencing feelings of guilt.

Before making any significant financial decisions and big life changes like quitting your job or selling your house, you need to give yourself some time to breathe and clear your mind. It is critical that your next steps are well thought through.


Prioritize your goals.

Once your emotions have settled and you are thinking with a clear head, it's time to reflect on your internal values and prioritize your goals. Considering that we all value different things, this will look different for everybody. For example, if you value education greatly, you may want to think about putting money aside to pursue a post-secondary program in the future. Also consider starting or contributing to your child’s RESP. If you greatly value experiences, then consider allocating some money into a travel fund. Making a list of the things you value most will help you map out where you want to allocate your money.


Review your current financial situation.

Being the recipient of a windfall can make you feel flush. It’s essentially free money. You can finally take your family on that luxury vacation you’ve been dreaming of. Or, maybe now you can finally purchase that cottage in Muskoka you’ve been eyeing. While looking towards the future is the natural inclination, it is important to remain realistic about your current financial situation and first account for your past financial debts.

If you don’t already have one, I advise that you hire an experienced financial advisor to help you develop an appropriate financial plan. Things to consider: current debts, long term income projections, tax consequences, spending habits, investment strategies, among much more. Depending on the size of your windfall, it also may be a good idea to set up a fixed monthly income plan with your financial planner to ensure you remain on track with your spending.


Pay off your debt.

Any debts – especially high-interest debts, should either be paid off or incorporated into your plan for the future allocation of your windfall funds. While paying off debt doesn’t necessarily seem like the best way to enjoy your windfall, being debt-free will allow you to be financially empowered.  For more information on debt repayment strategies, please check out my other article, ‘Debt Management: Living in the Red’. (hyperlink!!!)


Think of your future.

Depending on how much your windfall is worth and how you manage it, you could set yourself up for a very comfortable, secure future. Canadians are living longer, thus, there is a need for a greater retirement fund. Putting money towards your RRSP and topping up your yearly contributions to your TFSA are both good starts to providing for your future self.

Beyond preparing for your future, you may also want to consider your legacy after you die. How do you want to be remembered? Once again, depending on the amount of your windfall, you may want to consider making alumni donations to the post-secondary institution you attended, or start a foundation for something that is greatly important or meaningful to you.

Additionally, you should ensure that your emergency fund is topped up. This will help to mitigate the negative effects associated with unforeseen circumstances in the future.


Tax consequences.

Depending on the type of windfall you receive, you will be subject to different tax consequences. In general, though, Canada is quite relaxed about taxing windfalls.
According to the CRA, most financial windfalls are not taxed. This means that Canadian taxpayers do not have to report the funds from the windfall on their income tax return. While the principal amount is not taxed, it is important to note however, that if the funds from the windfall are invested, the interest earned on these funds is taxable as capital gains. This should be considered when developing your cash management and investment strategy.

Exemption: Professional gamblers are exempt from this tax-free rule and must report and pay tax on their winnings, as the winnings are considered to be coming from customary income sources.

Similarly, there is no inheritance tax in Canada. This means that if you receive a large inheritance, after any outstanding taxes are paid from the estate, you will not be subject to paying additional taxes on the amount you receive.  
Other examples of non-taxable items are GST and HST credit, amount paid for disability or death due to war service, life insurance payments, scholarships and bursaries, strike payments from your union, among others. While not all of these are considered financial windfalls, you can view a list of non-taxable assets on this CRA website.


Consider gifts.

Money is a taboo thing to talk about and tends to be at the center of many family disputes. Depending on the size and visibility of your financial windfall, you may find yourself in an uncomfortable position. You may want to gift some of your earnings to family members or friends. While this is a nice thing to do, ensure that you do not succumb to feelings of pressure or obligation. Having open lines of communication will ensure that people don’t have different expectations and help to alleviate any tension or misunderstanding.
Work with your advisor to ensure that gifts are incorporated into your financial plan and that you are not giving away more than you can afford.
 

Whatever the sum of the windfall is, it is crucial that your emotions are managed in a positive way that will help you make the best decisions for you and your finances. If you are the recent recipient of a windfall and are seeking advice on what to do next, first – take a deep breath. Working with a financial advisor who has experience dealing with windfalls and financial transition planning will allow you to feel more relaxed and capable of properly managing your newfound money.
 
Having become a Certified Financial Transitionist through the Sudden Money Institute, I feel confident in my ability to manage the financial and emotional components that come with windfalls or big life transitions. Please don’t hesitate to reach out to myself or the Bongard Wealth Advisory group if you are seeking any sort of help.