Suddenly becoming wealthy can present a unique set of challenges for clients. This fortunate situation can bring great joy and happiness but can also be stressful and, in some cases, traumatic. A windfall can bring on a condition psychologists call “sudden wealth syndrome,” which evokes a mixed bag of emotions, ranging from euphoria to fear.
How different clients deal with their sudden wealth varies. In most cases, your client will need some help to ensure that the newfound money does not “slip through their fingers,” says Heather Holjevac, a certified financial planner with TriDelta Financial Partners Inc. in Oakville, Ont.: “There is a lot of evidence of people ending up worse off, or back where they started, after experiencing sudden wealth.”
A windfall can come in many forms: an inheritance, an insurance or divorce settlement, lottery winnings, the sale of a business or some other unexpected event. The most common form of sudden wealth comes from inheritances. An estimated $1 trillion will be transferred to baby boomers over the next 20 years by their aging parents and grandparents.
But, as Holjevac points out, most inheritances are expected and, therefore, are not sudden. But, while the impact of an inheritance may not be as profound as for other forms of sudden wealth, such clients will still need guidance in dealing with their abrupt change in financial status.
Regardless of how the sudden wealth occurs, says Lou D’Aversa, senior financial consultant with MD Management Ltd. in Toronto, the underlying reaction of the beneficiaries is often similar.
Naturally, the size of the fortune makes a difference. A moderate sum of around $1 million can reduce financial stress but may not allow your client to quit his or her job. A much larger sum can mean financial freedom, Holjevac says, but it can also create emotional stress.
“More money should make you happier,” Holjevac says, “but it can give you more headaches.”
For instance, how is someone going to handle a sudden influx of $20 million?
“The first natural impulse is to give it away,” D’Aversa says, “especially to family members, for whatever reason – pressure or choice.”
Friends come out of the woodwork, D’Aversa adds, and people your client might not even know will present business ideas or ask for loans, putting your client under a lot of pressure and stress.
These clients need the advice of an experienced financial advisor to help them make the right decisions. What should you tell your clients who have come into sudden wealth?
“Look at the big picture and do a proper financial plan,” says Tina Jakma, an independent financial planner with T. Jakma Financial in Toronto.
In the meantime, D’Aversa says, move slowly: “Don’t do anything impulsive.”
D’Aversa recommends putting the money in a short-term investment such as a money market fund or even a bank account until you gain some perspective on what your client would like to do.
Put together a team that includes a lawyer and an accountant. This team should help you to generate ideas about the best course of action, D’Aversa says, taking into consideration your client’s personal objectives and financial goals. “Make sure [the team] is working together,” he advises, “in your client’s interest.”
Take the time to help your client understand what he or she has, Holjevac says, and the implications of any choices being made. “Sometimes, people overestimate the value of the wealth they have acquired,” she says, “and end up spending without thought.”
Depending on your client’s personal situation, there are some important steps you and your client should consider.
If any taxes are due, make sure your client pays these off first. Penalties on unpaid taxes can be costly over time, so they should be paid as soon as possible.
Urge your client to pay off all debts if the wealth is sufficient to cover them and still leave a financial cushion. Otherwise, consider which debts should be eliminated first. Start with high-interest debt, such as credit cards, Holjevac says. The rate of interest on some forms of debt, such as a low-interest mortgage or a secure line of credit, could be lower than what your client would earn if the money is invested.
Your client should treat his or her family to a vacation or some other reward. Jakma recommends clients spend no more than 5% to 10% of the total windfall on this.
Develop a comprehensive financial plan. The plan should address issues such as investing, estate planning and gifting.
Depending on the life stage of life your client, Jakma advises that you help your client determine whether he or she would like to leave a legacy.
If your client wishes to donate to charity, Holjevac suggests, set up a foundation — depending on how much money is allocated to gifts — and let the residual from the foundation fund any gifts.
The investments in the financial plan should have a long-term orientation, D’Aversa advises, and include hard assets such as real estate. He encourages a tax-efficient diversified approach using non-correlated assets.
The financial plan should take into account your client’s personal circumstances, risk appetite, time horizon and estate planning needs. IE