Incorporating a large lump sum of money into a financial plan requires thinking through a series of impacts that happen over time.
There are financial, emotional, tax, legacy, employment and a host of other issues to be addressed.
Whether the influx is due to an inheritance, an asset sale, or an IPO, taking some time to adjust before making any decisions is a good idea.
We get into some immediate implications, and then some further down the road.
Take Time to Breathe
Before you address the changes a large sum of money will bring, you may want to process the events that led to the inflow.
The loss of someone you care about, the sale of a business you’ve built, the monetization of the work you’ve put into a career are all emotional events.
The cardinal rule of investing is to remove as much emotion as possible. So taking time to work through the underlying feelings before you think about the ongoing changes to your life is a healthy approach.
Prioritize
By far the most important part of this process is to prioritize your actions.
There are some issues that require your immediate attention:
Following the death of a loved one, for example, there is the ugly “business” of processing and settling the estate. Good planning can help make this transition a smooth one, but there are still steps you must take those first few weeks and months.
Selling a business or having a large inflow of stock options require careful tax analysis, which we discuss below.
With any inflow of wealth, you’ll need to address these immediate deadlines.
However, you shouldn’t feel that you need to develop an investing plan right away. Yes, there may be opportunity costs of not immediately getting funds invested, but it is far more prudent to develop a disciplined investment plan to avoid making costly investment mistakes with large sums of money. And the volatility you may be used to with your portfolio takes on a different meaning when you add a zero or two to the end of the values.
Also, if possible, you should avoid any large amounts of spending right away. Your needs, wants, goals, etc. may change as you get used to your new reality, and you don’t want to do anything that can’t be undone.
By prioritizing what decisions you need to make first, you can more easily process the inflow of wealth to help you avoid costly mistakes.
Understand the Cost of Taxes
The money may be yours – but the government most likely has a claim on some of it.
Having a very clear accounting of how much tax is due and when, and how you are going to pay it, is the first step. The taxes due may come out of the lump sum, or it may be more advantageous to pay the taxes from other sources of funds. You’ll need a plan to understand the right choice for you.
For example:
- An inheritance may include very low-basis stocks that you do not want to sell. But it could have a step-up in cost basis that may warrant selling them first. Tax laws change over time, and understanding what you need to do to is critical.
- You may choose to structure the sale of a business in a deferred sales trust, so that you can minimize taxes. You’ll need to set up and implement that structure, and plan for gaining access to the funds over time.
- Post-IPO, you’ll be subject to taxes on your shares, and you’ll have some timelines you need to be aware of and taxes you’ll need to pay, whether you hold on to the stock or not.
Be sure to identify all tax strategies with a tax professional, because there may be ways to reduce your overall tax bill in the year that the event happens.
For example, if you have charitable inclinations, you might want to consider a gift in the year you received the lump sum. One example is via a Donor Advised Fund. Learn more HERE.
The ideal situation is to discuss potential tax implications prior to a large liquidity event when possible.
Rethink Your Approach to Risk Management – Both Investment Risk and Asset Risk
Adding a large sum to your overall financial picture will change how you think about risk.
You’ll need to assess your liability and protect your overall assets. This may mean an umbrella policy, structuring or titling assets differently, or in the case of an inheritance, it may mean a different insurance strategy.
Your investment goals may also change with time.
If you’ve sold a business and this is your retirement fund, your risk profile will look different than it did when you had a business creating income.
With an inheritance, an IPO, or other lump sum, you may decide to change, cut down, or stop work. This will create different time horizons for investing and different risk tolerances.
It may take time to understand what you want to do and put a plan in place.
Keeping assets as flexible as possible is the key to giving yourself choices as you move forward. You’ll want to minimize risk and avoid locking up funds until you have a clear understanding of your new goals.
Create a New Path Forward
Once you get used to your new situation, many people decide to make big changes.
These could include creating a legacy, actively gifting to help others, or using your funds to provide income for yourself so that you can devote your most valuable resource – your time – to causes you care about.
Or it may mean making a big purchase you’ve always wanted, travel, or just taking time to spend with family.
Most likely it is a combination of these dreams.
In the case of a business owner, you worked hard to get to where you are. You most likely made sacrifices that no one sees or knows about.
It is okay to enjoy your new wealth while still using it to positively impact others in whatever way you choose.
The Bottom Line
Thinking through your options means working carefully to create a financial plan that maximizes your assets, minimizes your taxes and provides for you and your loved ones.
The new plan may be bigger and more complicated, but the basic principles will still apply. You’ll still need to take the time to work with your team to set out what you want, and then put it into action.
We’re always here to talk it through with you.
