Managing a financial windfall

Receiving a financial windfall is often a life-changing event. However, successfully managing windfall gain is tough for most people as they might be in a state of happiness or extreme grief. In both cases it is quite easy to fall prey to financial evangelists, bankers, agents etc. Be careful to be able to take wise decisions.

1. What is windfall gain, how would you approach a situation like this?

• Windfall gain is receiving a large amount which is disproportionate to the amount of money you are used to dealing with on a regular basis.
• The events which bring this kind of money to you are sometimes happy events and sometimes events full of grief and agony. Each windfall gain event has its own set of tax consequences and emotional consequences. As a result financial decisions are likely to be a lot complex and often tend to be irrational. Possibility of financial mistake is very high and a 2nd chance may not be available.
• Many people end up losing a lot of it very soon – Easy come, easy go. This also happens because of lack of preparedness due to the element of surprise involved. They fail to make an organised plan to use this money. Taking the time to make well-thought-out financial decisions will help ensure that your money will last. Thus one needs to be more cautious when it comes to managing windfall gain.
• Such money should be used to increase financial security, health care, fulfil goals – Education and retirement and may also be used for certain other purposes like philanthropy, etc.

2. What should you immediately do? How to use the windfall gain? Consult someone? What is right approach?

• The first thing you’ll want to do after receiving a large sum of money is to take a deep breath. You may feel the urge to spend, invest, move, quit your job, or give to others.
• The next thing  you should do is to get unbiased advice from a financial professional or advice someone you know to get this done. Do not rely on friends, family and definitely on your insurance agent. Take a couple of opinions before you do anything. You may also subsequently need to work with an accountant, an attorney, estate planning specialist and other consultants if need be.
• Thereafter slowly and surely do things that turn your windfall gain into everlasting wealth… giving you safety security and long term prosperity.
• If you want your windfall to last, control the urge to spend lavishly, don’t do anything until you’ve had a chance to come to terms with the personal and financial consequences. If you plan well the benefit of such windfall gain can be profound in terms of financial security & comfort for years to come.

3. So could you throw some light on the various sources of windfall gain?

• Everyone gets windfall gain at some stage in their life.
• Common sources (4) – Investment maturity, Life insurance proceeds, Bonus / windfall business profits , Marriage etc.
• Special sources (6) – Sale of home, Inheritance, Lottery, Divorce settlement, Disputed money, Sale of business etc.
• The objective here is to understand the PATM formula. How to be Prepared, how to Avoid dispute, Tax implication, how to best use the Money available.

4. Could you explain how to manage the common sources of windfall gain?

Look at your annual investment calendar (IC) – so you know what is likely to come into your accounts this year.

• Investment maturity –
  • P – at maturity, A – applicable, T – applicable, M – as follows
  • Review IC & check title/nomination – if held in parents name etc.
  • Pay taxes if any / make tax provision
  • Roll over to get same / similar rate of returns – for conservative investors
  • Review overall financial plan
• Life insurance proceeds –
  • P – at maturity, A – not applicable, T – not applicable, M – as follows
  • Review IC & check if assignment of policy is removed (if applicable)
  • Roll over not a good idea – as products are not suitable for investment any more
  • Look at financial plan to decide best use of funds – Fund financial goals, use the money to service future term insurance premiums by creating a fund / pool of money.
• Bonus / windfall business profits –
  • P – unknown, A – not applicable, T – applicable, M – as follows
  • Pay taxes if any / make tax provision
  • Review personal financial plan. You can use your bonus to fund a financial goal.
  • Review business financial plan to identify best use of this money. You can redeploy your business profits to reduce OD level, use it toward business expansion, hiring more staff, purchasing machinery, premises, factory, make provisional measures like setting up a bankruptcy protection fund / litigation fund etc.
  • The idea of windfall gains is to achieve supernormal growth. If you use this frivolously and get complacent about growth, then you are not doing justice to this money. The purpose of this money is to help you leapfrog into the next level of progress.
• Marriage –
  • P – when you get married, A – Not applicable, T – Not applicable, M – as follows
  • Any amount received is not subject to tax, with due cognizance to the Income Tax provisions on gifting. Deposit the cash gifts received in your bank account, with the names and details of  the people you have received it from.
  • Use this money together to do whatever you need to do as couple to set up your life and family. Eg. buying a house, car, furniture, pay off loans taken for wedding or taken for parents, etc. Use it as a foundation to build a fund to provide for future financial goals.
  • Specifically for women – Money received from your family is your ‘stree dhan’ and should be used to secure your financial future against any eventuality. Create useful assets from your ‘stree dhan’ like property, stocks, equity mutual funds v/s gold etc.
  • Whatever you choose you do with your money, make sure you have absolute control over your funds. If need be, ask your parents to create a trust with you as the beneficiary.

5. Yes it is important to formulate a plan or strategy first. But till then is there something which I can do in the interim?

• You can consider putting your money somewhere temporarily for say 3 to 6 months. This must be done immediately. Until you’ve had time to explore your options, there’s nothing wrong with putting a lump sum into a relatively liquid account, such as a savings or liquid mutual funds.
• You don’t have to leave it there forever, just set it aside until you’ve had time to formulate a plan. This also includes the option of investing in your parent’s name / child’s name to gain tax efficiency.
• Don’t forget to have a little fun… If you feel like it. But proceed with caution. Do not spend more than 2% to 5% of your windfall immediately.

6. How about considering repaying debt with the common sources of windfall gain?

• Repaying debt is one of the best ways to use a windfall. However, here again, you need to distinguish between different types of debt.
• You should immediately repay high-cost debts, such as personal loans or credit card outstanding and debts taken to buy depreciating assets, such as a car or white goods.
• But, what about housing or educational loans, where you get tax benefits? One way is to leave them alone, the other is to make a partial repayment.
• Fully prepaying the mortgage debt on a self-occupied house may not be a good decision, but you can make a partial repayment and bring it down to the optimum amount.

7. How can one use the common sources of windfall gain in the financial plan?

• An important part of handling a financial windfall is to evaluate your short and long term needs and goals. This will serve as a foundation for your financial plan.
• It is important to ponder over these questions-
  • Do you have enough money set aside in an emergency account?
  • Do you want to upgrade the planning of children’s education?
  • Do you need to bolster your retirement savings?
  • Do you want to buy a second home to create a rental income?
  • Would you like to quit your job or go into business for yourself?
  • Are you considering giving or loaning money to loved ones or donating to a favorite charity? Would you like to create a trust? Or foundation? Or an NGO?

8. Now could you explain how to manage the special sources of windfall gain?

• Sale of home –
  • P – unknown, A – applicable & is very complex, T – applicable & acute, M – as follows
  • Check title and ensure it is free and marketable, records in sub registrar’s office are in order if it is based on inheritance (if applicable) and nomination in society records is in order,
  • Pay taxes on short/long term capital gains (as applicable), file returns to claim refund of TDS (if applicable). Especially applicable in case of NRIs.
  • Invest the money in another residential property / REC or NHAI bonds to enjoy exemptions from long term capital tax, use it to fund long term financial goals – Retirement or start a business if applicable. Before you invest in property, consider the potential of real estate growth as against equity market growth. This could be an opportune time to create an equity portfolio and thus liquidity in your net worth.  Create a trust for philanthropic purposes.
  • Before deciding on anything, invest the money into liquid funds so that you can immediately start earning something on that money.
• Inheritance –
  • P – unknown, A – not applicable since money already received, T – may be applicable, M – as follows
  • Create a way of thanking the person who gave you the inheritance. Eg. a trust, favorite charity of the legator (person who gave the inheritance to you). This is the best and most appropriate treatment to this money.
  • Next is (if you wish) to eliminate any discord and neutralize any unfair treatment in your opinion to other legatees ( who may have received lesser than you).
  • Eliminate any potential of conflict amongst immediate family members i.e. spouse and children. Plan together as a family so as to enjoy the perks of this money without any hassles.
  • Do not seek approval – You need not follow the investment style of the legator just out of sheer obligation.
  • Enjoy the privilege – Do not feel guilty about receiving this money. If you have got it, explore various options – if you want change your line of career, follow your passion, start a business, pursue charity. Feel free to enjoy this good fortune.
  • Do not forget to invest wisely to create long term wealth for your legatees.
• Lottery –
  • P – unknown, A – may be applicable, T – applicable, M – as follows
  • Pay taxes immediately without fail or on time to avoid any penalties or adverse action.
  • Compared to other sources of windfall gains, winnings from lottery becomes slightly more difficult to manage due to the element of surprise. As a result of lack of preparedness you may be vulnerable to all sorts of classic blunders.
  • A lot people may treat you like the goose that laid the golden eggs and will line up for loans. Use your discretion here.
  • There may be a possibility that the person who may have bought you the ticket feels that they are entitled to a share in the winnings. Address this claim upfront. Hire an attorney to help you understand your rights and obligations.
  • As result of your instant money you will find that a whole new world of opportunities and problems have been opened up. Driven by the initial feeling of excitement you may feel the need to splurge instantly on say a grand celebration, or on luxurious items you have been yearning for. But be careful and prudent. You may feel you deserve to splurge, but you also deserve to enjoy the benefit of your windfall gain for decades to come.
  • Prepare a wish list. List down all the things you want to do with this money. Then do a reality check (take the help of your financial advisor if needed). By doing your fantasy spending on paper first, you may find that you really don’t want most of the things on the list. Segregate your needs and wants. Make the most of your gain and park some money aside for future financial goals.
• Divorce settlement –
  • P – unknown, A – not applicable, T – applicable, M – as follows
  • Pay taxes if any / make tax provision.
  • For 6-12 months do not do anything with this money, especially if you are not used to managing money or a large amount of money because you have just come out if a lot of trauma which is mentally and emotionally draining. Thus do not do anything. Take decisions only when you feel you have come terms with your self esteem and are in a position to make wise financial decisions. Take a nice little holiday to relax and refresh yourself.
  • Make sure you change all your financial credentials, connections, access rights. All these need to be reviewed.
  • Make investments for your child (if applicable). Before doing anything else, secure his future.
  • Use the money as strong financial base to secure your and your child’s financial future (if applicable) to create secondary sources of income and then proceed to do long term wealth creating investments.
• Disputed money –
  • P – unknown, A – not applicable, T – applicable, M – as follows
  • Check title/nomination, pay taxes if any / make tax provision
  • Reimburse yourself all the expenditure you have borne to be able to receive this money. Think about alternate sources of income to be created using this money.
• Sale of business –
  • P – unknown, A – not applicable, T – applicable, M – as follows
  • Pay taxes if any / make tax provision
  • Review current financial position and goals. Consider investing it in another business or use it to create other sources of income.

9. Also give us some final tips, certain things one should avoid or general points to keep in mind?

• Avoid spending or giving your money away impulsively and risk depleting your nest egg.
• Although it’s tempting to go out and buy something you’ve always wanted but couldn’t afford before, watch your spending. Differentiate between needs and wants.
• A financial windfall can turn even a financially conservative person into an impulsive shopper.
• If your ultimate goal is to create lasting wealth, take time to consider your future needs, not just what you need (and want) today.
• Wait until you’ve set priorities and developed a financial plan before giving or loaning money to family and friends, or making a charitable donation. Otherwise, your personal relationships could suffer.