Surviving Sudden Wealth

Congratulations!

You've just won the jackpot. If you keep your head, you may be able to keep most of the prize for more than a year. If you don't you could be living in your truck.

All of the information in the following pages is general and your situation may be completely different. That said, there are things to think about no matter what your situation is.

In Canada, lottery winnings, other 'found' money and money from an inheritance are not considered income for tax purposes. Interest earned from investing that money is considered income, but that's next year's tax bill and there are ways to minimize it. The US taxes things differently. Some winners on game shows forget that they need to pay tax on the new car they just won and end up having to sell the car, home or boat to pay the taxes. The IRS person is standing just backstage.

When the call comes, or you check the winning lottery numbers, you're in shock as is the rest of the family. First- breathe. Second, maybe take another breath. Don't phone everyone you know to tell them the news. If you want to bounce around the house for a couple of hours doing the happy dance of joy, do it. Eventually you will calm down and start to think.

I suggest not calling everyone because you may not really want everyone to know that you have a lot of dollars to play with. They may come and help you spend it before you can figure out what the needs and desires of your own family are. There are many stories of people who won the lottery and it ruined their lives. Don't be one of them. By thinking about your priorities now, before the big win, you have a chance to stay in control if it does happen. Another consideration is that some big lottery wins pay a certain amount per year over twenty years, not a lump sum. This can make a huge difference in thinking about how you plan to use the money.

Sit down with your family and make some plans on what is important. Initially, just jot down everything people suggest. You can sort through them later. Brainstorm first.

1. Plan to do something frivolous with 5-10% of the money. This could be a great vacation, a down payment on a vacation cabin, a new car, seats at the opera, going to a rock concert in Europe or whatever you feel like doing.

2. The boring part – pay off bills like credit cards, car loans, student loans and so on. The majority of government spending goes into paying interest on debt, not on current programs. Why should you pay someone else massive amounts of interest when you can pay off the bills with the found money and then relax and enjoy more of your income?

3. Look at your housing and mortgage situation. If you don't own a house, consider using some of the found money for a down payment. Many mortgage payments are nearly what the rent payment is. If you plan to be in the same city for the next four or five years, you will be ahead in terms of built up equity in the house. Most of the time, the price of a house will only go up. There have been and will be exceptions to this, but it is a good idea a majority of the time.

Does it make sense to pay off or at least pay down your mortgage? Many mortgages can be paid off at the end of term, or paid down on the mortgage anniversary. There is usually some form of penalty to pay it off during the term, but asking the bank manager what their policy is will help decide what is best to do. It is possible to start an account that will hold the money to pay off the mortgage when the term is due or to make all the payments until the end of the term.

Another possibility is to decide that your present house is not suitable and to sell it and buy something else. If you can't buy the new house outright, will you have enough income from your found money to make the new and probably larger mortgage payments? Another consideration is how much money does it take to maintain that bigger house. Property taxes will be more, as will utilities. You may decide that your current furniture doesn't fit the new lifestyle and you need (want) all new. This can be very expensive.

A third option is to stay in your present house and do some upgrades – a new kitchen, develop the basement, do a new garage. Be sure that you hire a reputable contractor – watch shows like Mike Holmes on HGTV to get an idea of what can happen to the unwary consumer.

If you run a home business, paying off your mortgage may decrease the amount of deductible that you're taking from the business income. Consult your accountant if you have one.

4. Retirement savings – Is the amount reasonable to provide income for an early retirement? You may wish to keep working for a while, or to work part time while you sort out what is best. Don't automatically quit your job unless you've won a very substantial amount. You can backfill your RRSP from previous years and thus decrease the tax you'll need to pay on the earnings from the found money.

5. Investment – Consider investing in yourself, your family and your dreams If you wanted to start a business, now is the time to think seriously about the possibility. Going for retraining for a new career, buying a franchise or just starting or expanding an existing business can provide you and your family with a continued source of income.

Other family members may feel that you should give (or lend) money to them. They may be in real need, but you could also be setting them up to be a perpetual drain on your economy.

Investment in someone else's dream can be a great way to lose your money. Think carefully and if it is for a business idea, get legal advice and tell the person you need to see the business plan. Be sure there is a paper trail connecting you to your investment. A contract will ensure that if the venture fails, you have legal recourse. On the other hand, if it succeeds, you also get your investment back with interest.

6. Charitable donations – The inundation of Ralph Bucks ($400) from the Alberta government got the attention of all sorts of non-profit organisations. Every one seemed to have its hand out. Donations are always needed to help these organizations, and you should consider making donations to something on a regular basis. It could be your church or faith group, a medical charity (many fund research in a particular condition), to help the homeless or to groups that seek to help those who have suffered natural disasters. Most of these groups give tax receipts so you will decrease any tax owing. There might not be much left after dealing with your family's urgent needs, but this is always something to consider. Keep your charitable contributions in the country you live and pay taxes in. Directly contributing to a US charity from Canada, for instance, is not eligible for the donation tax credit. Most international charities have offices in Canada for that reason.

It may not seem like much fun to spend your winnings or inheritance on bills and the mortgage, but the goal is to be no worse off at the end of a year than you were before you got the money.

Some examples

All the scenarios below are based on a family of four with both parents working, dad full time, mom part time. Children are 15 and 17. There is a car loan of $6,000 and the Visa has $1,800 on it. The mortgage is $120,000 with a $600 monthly payment.

Interest on investments is considered to be 6%. It is possible to do much better or much worse.

$5,000 win

Frivolity is 10% or $500. Is there a new toy you've been wanting, or a trip to visit the grandparents?

Pay off the Visa and see if you can pay down on the car loan.

If you don't pay on the car loan, there is $2,700 left. This isn't a lot, but it could be invested to provide some funding for the children when they graduate and are looking at university. Any charitable donation would gain a tax receipt which will lower other income levels. RRSP donations are always a good idea.

$50,000 win

Frivolity is 10%, so that's $5,000. Disneyland, here you come.

Bills – Pay off the car loan and the Visa bill.

This leaves $37,200 for mortgage, home improvements, charities or RRSP. Paying off the mortgage is not possible, but investing the money at 6% will give you $2,232 per year. You can use this to pay down yearly on the mortgage, or to put in the RRSP to give you more deductions. You can also put some into an RESP or a general savings account for the kids for university (but since they are near the age when they'll need it, a high yielding account is probably best), or divide the money up to develop the basement and to invest the rest for the future. Both parents will probably need to keep working. Consider an ongoing donation to Doctors without Borders or another group working to help people in other countries.

$500,000 win

Frivolity is getting large, so only 5% is allocated but this is still $25,000. That's a lot of fun waiting to happen for your family. Spacing it out over time will ensure a great vacation or whatever fun you want on an ongoing basis.

After paying the bills (car loan and Visa), there is $467,200. At 6%, that is $28,032 pr year. Consider paying off the mortgage. If you don't, at least one parent may be able to stop working or to return to school for a new career. Helping subsidize grandpa's nursing home bills might be a way to help family. Ongoing charitable donations will make the world a better place. Depending on other savings, it might be enough to allow both parents to stop working the day jobs and start a new business. Do some careful sums and remember that health and dental care is often subsidized by the employer and if both parents stop working for others, that will be an added expense.

$5,000,000 win

At 5%, $250,000 is a lot of frivolity. Buying a vacation cabin or time share outright, hot new car, the biggest TV in the neighborhood or whatever is wanted.

After paying the bills and the mortgage (unless you want to buy another house) it is time to invest. Assuming you pay the mortgage, you'll have $4,622,200. At 6% interest, that is $277,332 a year. Early retirement, helping family, donating to charities and just about anything else is possible. Consider starting or contributing to a scholarship at a local university. Leave the principal alone and consult someone to help you decide how to invest and then deal with the tax implications.

Most large sums like this pay out yearly, not as a lump sum. You might get $200,000 a year for 20 years. That's enough to allow for both parents to retire, pay off mortgages and still have plenty left over.

The problem with winning a sum like five million dollars is that most people really don't think in terms of that much money. Even comprehending how to spend the interest on the residue ($277,000 a year) in the last scenario is more money than most people think to see in their lifetimes.

The more money you have the more work it takes to care for and maintain it. You can't expect to shove the entire responsibility for your money onto someone else and expect to be happy with the results. After all, it's not their money, so if it gets lost on risky investments they'll just move onto the next client.

There are two important people who will need to come into your life if you win a major jackpot: the accountant/tax person and the investment councilor/financial planner. They could be the same individual or firm. Check them out with the Better Business Bureau, your Chamber of Commerce and ask for references from at least three individuals. You must interview them for the job of looking after your money. They must show reasonable competence at the job or you shouldn't deal with them. Just because your hairdresser's wife's second cousin is in investments is not an overwhelming reason to hire that person and hand them all of your money. Also, if they suggest that you to invest in things that you don't understand, find another advisor.

Good luck – you'll need it to win.