Three steps to managing sudden wealth

How not to blow inheritances, gifts, lottery winnings

For those few who are lucky major lottery prize winners or for those who are the recipients of an unexpectedly large inheritance or gift, the real question isn’t how to spend it…it’s how to keep it. For people in this rarefied group, my advice is always to start with these three first steps.

1. Preserve your capital

As a recipient of sudden wealth, your big challenge is how to keep it from evaporating from the edges in. Capital has many enemies, but three of the biggest outside forces are inflation, taxes, and macroeconomic forces. These are factors that you don’t directly create yourself (like paying for shots for the whole restaurant or bar, or buying three mega-yachts, when one will do). They’re part of the wider world, and your approach to these realities must be purely defensive.

For example, the $50 million LottoMax winner starts to lose purchasing power as soon as that amount is transferred to their bank account. Inflation in August was running about 1.9% annually. Doesn’t sound like much, does it? But on $50 million, that’s a loss of purchasing power of $950,000 in a year! You haven’t actually done anything except leave your money in a bank account at a near-zero interest rate for a year, and you’ve lost what many people earn in 20 years.

The Canada Revenue Agency isn’t far behind in being a destroyer of that newfound wealth. Put that $50 million lottery winning into 2-year Government of Canada bonds, which were recently yielding 1.36%. Over a year, while you decide what to really do with your fortune, you’ll receive $680,000 in interest income. Being interest income, that will be taxed away at your top marginal rate (which for you will be the top rate), say around 52%. You’re left with $326,400, still pretty much a king’s ransom for most people, but still…you’ve forked over $353,600 to the feds. Note that the after-tax yield of 0.65% is less than the current rate of inflation for the same period. Any way you look at it, you lose.

Remember, too, it doesn’t matter how many zeros we’re talking about for your nest-egg here. Move the decimal place to the left, and the story is the same one. When you’ve built up (or been handed) a tidy nest-egg, preserving it is job one.

2. Control your spending

You’d think it would take some doing spending a few million bucks. But all those yachts, private jets, exclusive vacation villas, luxe homes and cars for family and friends, and hobnobbing with the high-flyers will drain that that lotto win pretty fast. Surprisingly, even those high-earning, high-net-worth individuals who made it to multi-million status the hard way often find themselves in a cash flow bind, always “broke,” with creditors banging on the doors.

A sensible financial plan will bring that sense of imminent financial doom under control. To start with, big lotto winners or beneficiaries of large inheritances would do well to take some portion of their windfall (say, 20% or 25%) and blow that any way they want, just get it out of their system. On a $50 million prize jackpot, that comes to $12.5 million, which will still take a bit of burning, even in this day and age.

3. Make it grow

If you happen to win a large lottery jackpot and you’re offered a choice of a lump sum or annuity (in the case of the various weekly or daily “cash for life” lotteries), the smart thing to do is to take the lump sum. With the right advice and some smart, tax-efficient asset allocation, you’ll still end up with that regular payment, and you’ll very likely increase the size of your original lump-sum winning considerably.

Capital preservation for that nest-egg is all-important. With larger amounts, it becomes more of a headache. So it’s crucial to make some decisions about your tolerance for risk and from there how to allocate those assets in the most tax-efficient way possible.

Leaving it in a bank account might seem the easiest option, but we’ve already seen how your wealth can evaporate with that approach. So think about diversifying assets over a number of classes (including fixed-income, equity, and alternative investments) using a variety of strategies, including hedge funds, venture capital, private offerings, tax shelters, and other vehicles for “accredited” investors,” to ensure both capital preservation and tax-efficient growth to keep that income stream coming.

Sophisticated tax and investment strategies that can make this all work are definitely not a “do-it-yourself” proposition. A skilled financial advisor who can tap into a network of opportunities for high net worth individuals is essential here. And so for such individuals, getting the right financial advice from the beginning would have to be step number one.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.