Plan Carefully If You Win the Jackpot
Picture this: You've just won the lottery or received a large inheritance. You start daydreaming about all the wonderful things you'll buy and all the vacations you'll take.
Money will no longer be a worry. Unfortunately, it may not be quite that simple. If you don't properly plan on how to receive your windfall and invest it wisely, you could find yourself not on Easy Street but on the road to financial disaster.
If you find yourself rich overnight, here is some advice you may want to consider before buying that new sports car and quitting your job.
Take lottery winnings in a lump-sum. If you're disciplined enough not to spend the money all at once, you may want to consider taking it all in a lump-sum. Typically, receiving your winnings in this manner will give you more money in the end than if you were to be given payments over the years. For example, if you receive $1 million and pay half of that in taxes, you'll end up with $500,000 to invest. At a hypothetical 10 percent rate of return, your winnings would have the opportunity to grow to more than $3.3 million in 20 years. By comparison, if you chose to receive your windfall in 20 annual installments of $50,000 and invest each year at that same 10 percent, you would end up with approximately $2.8 million — a difference of more than $500,000.
The more money you can get invested right away, the better off you could be.*
Choose the installment option if you're a spendthrift. On the other hand, if having an account with a lot of money in it is too tempting for you to handle, take your fortune over a period of several years. You may not have this option with every type of windfall, but if you happen to win the lottery, the sponsor may invest your winnings for you. You may get a better rate of return by taking the money in a lump-sum, but that's no use if you end up spending all of it without planning.
Keep income taxes in mind. Most likely, about half of what you win or inherit will go to pay federal and state income taxes. And remember, a multimillion-dollar payout this year would put you in the highest federal tax bracket at 39.6 percent. Add state income taxes to that, and you may end up losing half of your money to taxes. In cases where winning lottery tickets are purchased outside your home state, it's possible that you would be taxed in your home state and the state where you purchased the ticket.
Careful tax planning can help you keep as much of the money as possible. What happens when you die? If you're married, the money – no matter how much – may be transferred to your spouse free from estate taxes. However, if you're single, the amount totals more than $5,340,000, and you die this year, your heirs may have to turn over 40 percent of it to the federal government in the form of estate taxes.
As you can see, without careful planning, a financial bonanza could become a nightmare. A financial adviser can help you take appropriate steps to help you manage the windfall more effectively.
*This example is for illustrative purposes only and does not reflect the performance of any specific investment. There is no guarantee you would be able to obtain a consistent rate of return.
This article was written by Wells Fargo Advisors and provided courtesy of Jonathan Buoni, Financial Advisor, in Springfield, MA at 413-755-1171. Wells Fargo
Advisors LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. ©2013 Wells Fargo Advisors LLC. All rights reserved.
