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The 3 Biggest Money Windfalls You’ll Ever See, and How to Make Sure They Don’t Go to Waste

Following a smart investing strategy to build up wealth and achieve financial independence can take an entire lifetime to achieve. Yet many people face just a few pivotal moments in which their paths cross a large sum of money and they have to figure out what to do. The choices you make in situations involving major monetary windfalls can make or break your overall financial planning, so it's important to get as much information as you can about the best ways to handle these key life events and how to avoid the common mistakes that so many people make when they have similar situations. By taking action and getting the assistance you need, you can position yourself so that major money events in your life could help you make substantial progress toward your overall financial goals rather than turn out to be missed opportunities.


Major money event No. 1: Leaving your job

So much of your financial life is tied up in your work that when it comes time to leave your job, you'll almost inevitably face some money challenges. If you're switching jobs to work somewhere else, then you'll have an opportunity to take whatever retirement savings you've set aside in your old employer-sponsored retirement plan and consider a number of options with it. If you've been let go, then some employers offer severance packages that can pay you a substantial sum of money in a single payment. Lately, many companies have also sought to reduce their risk of pension liability by offering workers lump-sum buyouts of their monthly pension payments. When faced with these situations, many people tend to focus their thinking on near-term needs while leaving key considerations untouched.

The four key money mistakes people make when they leave their job

There are many opportunities to get tripped up when you leave a job, and missteps can have huge consequences. In particular, the following mistakes can erase years of progress you've made toward achieving financial independence:

  • Cashing in your employer-sponsored retirement plan account. Doing this can result in early taxation of your retirement savings and force you to incur early-withdrawal penalties from the IRS as well. You'll also lose years of future growth from those savings.
  • Rolling over a retirement plan account into your new employer's plan without considering alternatives. This move is smarter than simply cashing in your retirement plan, because a rollover to your new employer's plan avoids taxes and penalties. However, by doing so, you give up the chance to open an independently managed IRA instead, which could give you far more flexibility than most employer 401(k) plans do in choosing the investments you want.
  • Forgetting that severance pay is taxable. The IRS views severance pay as a replacement for work income, and so they treat severance the same way as wages for most tax purposes. That includes not only federal and state income taxes but also Social Security and Medicare withholding taxes in most instances. If you assume that every penny you receive in a severance package will be yours to keep, then you're in for a rude awakening when the tax man comes knocking on your door. Moreover, a big upfront severance lump sum can push you into a higher tax bracket, creating brand-new financial challenges.
  • Choosing the wrong option for pension buyouts. A lump sum can be extremely attractive, and in some cases, it's the right move to make. But it always makes sense to evaluate other options you might have, including the right to receive monthly payments over the remainder of your lifetime. If there is also an option for a survivor benefit, then the choice becomes even more complex and raises the stakes for your spouse’s financial security. Even if a lump sum is the right move, you need to come up with viable investment strategies to make it last a lifetime, since its purpose is to replace the monthly pension payments that your employer would otherwise have had to pay to you.

Key money considerations for those leaving their jobs

Instead of making these common mistakes, you need to take a close look at your situation and take the time to figure out fully the best way forward. That involves several vital considerations.

First and foremost, you need to figure out the best way to handle your retirement plan account with your old employer. Cashing it in is almost never the right answer, and the better choice is to consider a rollover either to a new employer plan or to your own IRA. If your new employer plan has investment choices that match what you want and are inexpensive, then it can be a smart destination for your old employer plan money. Otherwise, opening a rollover IRA is the better move, as you can take steps to go beyond the basic and often costly mutual funds that most employer retirement plans offer as investment options. In particular, IRAs that offer exposure to individual stocks can present an entirely new opportunity to make your money work harder for you.

Second, once you decide which vehicle will hold your retirement money, you'll need to invest it as well as you can. Coming up with an appropriate asset allocation can be difficult, especially if you always had that aspect of your retirement investing handled through your old employer's predetermined menu of mutual fund investment options. Some employers have relationships with particular advisors who offer advice to workers, but some people choose to get independent assistance from professionals who aren't affiliated with their employer. They believe this makes it more likely that these advisors will have their best interests at heart.

Finally, if you're in a situation involving a severance package or lump-sum pension payout, integrating tax assistance with individualized investment planning that will help you stretch whatever amount of money you received as far as it can go for the rest of your lifetime is important. Many brokers and other types of financial advisors can't give you that level of help, but diligent wealth advisors either have people on staff to help clients or have relationships with other professionals to help you get the answers you need.


Major money event No. 2: Getting an inheritance

The death of a loved one is one of the most stressful things you'll ever face. Not only do you have to deal with the emotional loss involved, but you may also have to handle wrapping up an extensive number of financial issues for the loved one's estate. Even if there's money left over to provide you with an inheritance, there are special challenges that you'll need to overcome in order to honor the memory and intent of the deceased person to help improve your financial life.

The four key money mistakes people make when they receive an inheritance

During the period immediately after a loved one dies, you'll be especially vulnerable to making mistakes. As hard as it is to deal effectively with money matters when you're grieving, the consequences of not doing so are too great to ignore. The following problems come up time and time again with people who receive inheritances:

  • Spending the money too quickly. For many people, an inheritance will represent the first time that they've been able to spend money freely without having to factor it into their regular budgeting. It's especially tempting during times of stress to treat yourself, but it's important to moderate your spending of an inheritance to ensure that it can help you achieve long-term financial goals rather than merely act as an emotional crutch at a difficult time. In addition, you need to know exactly what obligations you might have as a result of receiving an inheritance, such as special taxes or the maintenance and upkeep costs of property you may have received.
  • Misunderstanding your options with inherited retirement accounts. The rules governing IRAs and employer-sponsored retirement plans are complex, and different options are available that in some cases can help you extend for decades into the future the tax deferral that these retirement accounts offer. To take advantage of these provisions, however, you have to take certain actions within a specific time period, and you have to avoid doing other things that can take away your ability to gain additional tax deferral from an inherited retirement account.
  • Investing in a less-than-ideal way. Some people develop an emotional attachment to money they inherit, and that can result in investing that money less aggressively than they would the money they've earned themselves. An inheritance can reduce your need to take risks with investing, and that in turn can lead to more conservative overall asset allocations. What's important is not to invest an inheritance conservatively simply because it's an inheritance.
  • Missing out on multigenerational planning. For families with larger amounts of wealth, the death of a loved one can have dramatic tax implications for both the deceased person's estate and for heirs. If your financial needs have already been handled effectively, then there are opportunities to engage in smart tax and estate planning that can enrich future generations. The window to use these strategies is small, so you have to be ready to act.

Key money considerations for those receiving an inheritance

Despite the challenges involved, overcoming your grief and making smart decisions about your money are crucial. To do so, you'll need to keep several things in mind.

First, you should rationally evaluate the impact of your inheritance on both your short-term and long-term financial health. For many people, an inheritance represents a key chance to catch up on neglected financial planning, providing much-needed wealth that you can use to jump-start your saving toward key financial goals like retirement. If you've already handled your own finances well, then you can consider other options for putting your inheritance to work, including providing for the financial needs of future generations in your family or taking on philanthropic efforts.

Next, it's important to understand just how long the process can be for dealing with inheritances. You can count on even simple estates taking months to settle, and more complicated situations can take years. The resulting stress can tear families apart, especially if there's already a base level of animosity among family members. If you're involved in the administration of the deceased person's estate, you can find yourself in the middle of heated conversations among multiple heirs. If you're not, you can feel like you're on the outside looking in at a difficult process over which you feel you have no control. Neither of those positions is ideal.

Finally, you need to know about any immediate implications that your inheritance might have for your own finances. A handful of states impose inheritance taxes on money received from a deceased person, with rates as high as 18%, depending on the state in which you live and the relationship you have with the deceased. In general, the closer the relationship, the lower the tax rate, but even close relatives don't always escape with no inheritance tax at all. The deceased person's estate is also responsible for covering any state or federal estate taxes that might be due, and every dollar that goes to the IRS or to your state tax authority is one less dollar for you and your fellow heirs to receive. By the time a loved one dies, it can be too late to take advantage of some tax-reducing strategies, but others might still be available even at that late date.


Major money event No. 3: Selling a key asset

Over your lifetime, you'll gather a huge number of assets -- more than you'll know what to do with. Getting rid of most of them is as easy as having a garage sale or giving them to charity. But when it comes to sales of key valuable assets -- things like your home, your business, or a large investment position -- the amount of money is so large that you can't afford to make unnecessary mistakes. Some assets are easier to deal with than others, but whenever there's big money involved, it pays to be careful and to know exactly what you're getting into.

The four key money mistakes people make when they sell a key asset

Selling an asset might seem simple, but it can be fraught with peril if you're not careful. In particular, many people make these mistakes when they're selling their most valuable assets:

  • Ignoring taxes. Selling a key asset almost always has tax consequences, and you need to be prepared for them. With a primary residence, tax exemptions often keep you from paying tax on your gain on its sale. Business sales are a lot more complicated, especially if you have depreciated property in the business or have taken other special tax incentives. Most investments will incur capital gains tax when you sell them. There are even special tax rates for selling collectibles like coins or art. The way you structure a sale of a key asset can sometimes reduce the impact of taxes on how much you end up with after a transaction.
  • Not knowing appropriate fees. Sales of key assets can require assistance, and that help doesn't always come cheap. Selling a home generally comes with a 6% commission if you use a real estate agent, although some less-expensive alternatives have come into vogue in recent years. Getting professional assistance with your business often involves valuation services and other professional fees at an hourly rate, which can be either good or bad depending on how much effort it takes to complete a sale. Investment brokers typically take sales commissions when you sell investments, but those fees can vary widely, depending on the company with which you have a relationship.
  • Forgetting to rebalance your asset allocation after you sell an asset. When you sell a key asset, you'll suddenly have a large amount of cash available, and what you do with it is extremely important. If the asset is an investment, then you'll either want to replace it with a similar investment or make a conscious decision to invest in something else and thereby change your overall asset allocation. If the asset is your home or business, then when it comes time to reinvest the sale proceeds, you'll want to carefully weigh whether to invest in a way that preserves your existing asset allocation or changes it to one that's more in line with your new tolerance for risk.
  • Making incorrect assumptions about replacing one asset with another. Many people consider things like downsizing to a smaller home when they retire, or they might sell off riskier assets to replace them with more conservative ones. Yet it's often surprising to discover that smaller homes aren't always that much less expensive than larger ones, especially if you're looking to upgrade certain amenities in the move. Similarly, when you choose more conservative investments, you might suffer losses of income or gains that require you to take other steps to earn back that income elsewhere.

Key money considerations for those selling a key asset

Keeping track of all these potential pitfalls can be tough, but it's important to know where you stand. Being smart about selling a key asset requires considering several key issues.

First, you'll want to integrate tax planning into the sales process. For example, with a home sale, there are rules about how long you need to have lived in the residence you're selling, and you'll have to follow them if you want to take the exclusion for capital gains on the sale of your principal home. Various business tax provisions in a purchase-and-sale agreement can make big differences in who ends up responsible for various taxes, and with major investment sales, coordinating the sale of some property at a profit with the sale of other property at a loss can help net out potential tax liability.

You'll also need to consider the collateral impact of an asset sale in financial terms. From a financial perspective, business owners often find that once they sell their business, a number of the things they used to claim as business expenses are no longer available as tax deductions. That can result in paying more tax as well as increasing overall living expenses, both of which will have an impact on retirement income needs. Homeowners who sell can lose deductions on mortgage interest and real estate taxes, offsetting some of the savings. Moreover, converting a profitable business into cash requires you to find ways to generate the income that your business used to provide, and that can be challenging for many people.

Finally, what you do with the proceeds of a sale requires important consideration. In many cases, you'll have to invest whatever you get from a sale carefully so that it can support you in the future. Replacement investments can work out better than the originals, but there's usually a risk that they'll turn out worse, and weighing those risks can be tricky.

How to get help

With all these situations, you might find yourself needing help. That's perfectly understandable, and the right financial advisors can give you the assistance you need.

In particular, keep the following things in mind:

  • A good advisor will be able to look at various options you might not have considered. Whether it's different payout options for an employee pension, choices about retirement account inheritances, or comparing the tax implications of liquidating key assets in different years, experienced advisors can be invaluable in helping you navigate these challenging events.
  • Professionals who offer access to individually tailored investment accounts can give you more flexibility than you'll find with more traditional alternatives. Many investment advisors rely on mutual funds or exchange-traded funds to give you the diversification you need. Some investment advisors who offer separately managed accounts, on the other hand, can give you the chance to invest in individual stocks rather than funds. The potential rewards from individual stocks can be much greater than what you'll get with funds, and if the pricing is competitive, it doesn't have to be more expensive than a fund-based option.
  • Understand how your advisor gets paid. The best advisors are upfront and honest about their compensation, and they aren't afraid to ask you to pay what they're worth. Too many professionals hide their fees through complicated commission structures. In particular, commission-based advisors always have a conflict of interest in that they want you to buy something, whereas those who get paid in other ways can give more objective advice.

Be smart with your major money events

To be successful in saving for long-term financial goals, it's essential to focus on fundamentals, being smart by regularly setting aside money paycheck after paycheck. Yet you also have to recognize that major life events like the three discussed above can have a disproportionately large impact on your overall financial health. Respect these situations by taking maximum advantage of them, and you'll get a lot closer to your financial dreams in the long run.

If you don’t have a financial planner to discuss these situations with — or would like a second opinion — we’d love to invite you to learn more about the personalized solutions we offer here at Motley Fool Wealth Management. It could make the difference in maximizing your opportunity.

So, go ahead, click the button below, and see if we can help you build an investment portfolio that’s right for you.

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The content in this message is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues.

During discussions with our Certified Financial Planners, they may provide advice with respect to 401(k) rollovers into accounts that are managed by MFWM. Such recommendations pose potential conflicts of interest in that rolling retirement savings into a MFWM managed account will generate ongoing asset-based fees for MFWM that it would not otherwise receive.