Everyone dreams of winning the lottery — and most people think that winning a large chunk of cash would suddenly, miraculously, solve all their problems, not to mention make life a lot more fun.
The reality is much more sobering: the National Endowment for Financial Education estimates up to 70 percent of people who come into sudden money — whether from a lottery or, more often, from an inheritance, insurance settlement, pension payout or the like – will deplete those funds within just a few years.
The stories of lottery winners who’ve blown through millions with frivolous purchases and high-price living are always headline grabbing. With examples of such epic financial failures – especially among the mega, multimillion-dollar winners — there’s even become a bit of a social stigma attached to winning the lottery: Joe Nocera wrote about it in a 2012 New York Times column entitled “The Bad Luck of Winning.”
Statistics on the bankruptcy rates of former professional athletes – who often come from humble backgrounds to find sudden, sometimes enormous wealth during their careers – are equally stunning. Sports Illustrated noted in a 2009 article that 78 percent of former NFL players had gone bankrupt within two years of their retirement, while roughly 60 percent of former NBA players were broke within five years of their final game.
But why is this the case? Why is it so hard to hang on to sudden wealth, and is there a way to make these funds last?
There is, says Don McNay, a financial advisor and national expert on the habits of lottery winners based in Richmond, Ky. Often quoted by national print media and invited to appear on national television programs including the “CBS Evening News with Katie Couric,” McNay pens frequent columns for The Huffington Post news website about how to manage sudden wealth and has authored three books on the topic: “Death By Lottery,” “Life Lessons from the Lottery” and “Son of a Son of a Gambler: Winners, Losers and What to Do When You Win the Lottery.”
For lottery winners in particular, it’s crucial to try to remain anonymous if possible, McNay advises. Otherwise, winners often fall victim to requests for financial help from scores of friends and distant family members.
Spread the payout if possible
The second most important step: Never take the lump-sum payout – advice that McNay says translates to insurance settlements and pension payouts as well. One advantage of the lifetime payout is that it lessens the temptation to squander the money all at once.
“If you get a $100 million payout and you run through it in a year, it’s gone,” McNay says. “But if you get $5 million a year (for 20 years from a $100 million win) and you run through it, you get 19 more chances to get it right.”
The essential problem for most lottery winners – and for many others who may suddenly find themselves the recipient of an insurance payout or inheritance after the death of a relative – is that they often don’t have a financial support team in place to help them invest and allocate their money wisely.
“For lottery winners, hanging on to the money is often very hard. One day, you’re a chef, the next day you’re a multimillionaire. They didn’t expect it, they didn’t earn it, and they don’t have any systems in place to protect those funds,” McNay says. “So as advisers, what we try to do is to catch them up front – before they have a chance to spend through it – and put that money into a trust, put it into annuities. We want to put it in places where it will be harder to get to. If we can do that, we have a chance of keeping them from becoming a statistic.”
Build a team – immediately
In a frequently cited 2011 paper titled “The Ticket to Easy Street? The Financial Consequences of Winning the Lottery” published by The Review of Economics and Statistics, University of Kentucky College of Public Health professor Scott Hankins, an economist by training, analyzed the bankruptcy filing rates of Florida Lottery winners, coming to a rather unsettling finding. Working with co-authors from the University of Pittsburgh and Vanderbilt University, Hankins tracked the rates of bankruptcy filings of Florida Lottery winners who won both large ($50,000-$100,000) and small ($1,000) amounts.
“What we found was that over a five-year period, the people who won a large amount of money in the lottery, say $100,000, were just as likely to file for bankruptcy as someone who won a small amount, or $1,000, which was our control group,” Hankins explains. “What this finding strongly suggests is that it’s not necessarily money that’s causing people’s problems. It’s how they’re managing it.”
In other words, Hankins’ study illustrates that some people are, unfortunately, innately poor money managers: No matter how much – or how little – money they have, they’ll always spend it all.
McNay agrees, summing it up this way: “The problem is wealth. Once people have it, their bad patterns only get worse. If they’re living below their means before they get wealthy, they still will afterward. But if they’re living beyond their means when they’re broke, they will even more so when they’re rich.”
To avoid falling victim to such sudden wealth mismanagement, experts say it’s essential as soon as possible to build a key team of advisers to include, at minimum, a certified financial planner, an attorney specializing in estate planning and a certified public accountant.
Timing is also essential. In the case of an inheritance or life insurance settlement following a death in the family – far and away the most common sources of sudden wealth windfalls in most peoples’ lives – there are some immediate financial and legal steps that will have to be made. These include paying for funeral arrangements, filing for death certificates and dealing with other necessarily paperwork required by the courts, said certified financial planner Amy S. Jones, an investment associate with Barlow Associates at Merrill Lynch in Louisville
Cooling-off period is good investment
Once these initial steps are done, Jones advises clients to take a “cooling-off period” of at least two and perhaps as much as six months before doing anything else with the money.
“We advise against making any large purchases during this time. We don’t want clients buying or moving to a new home, or for that matter going on a shopping spree and buying lots of personal effects. It’s important to give yourself time to process your emotions, first. If you’re not in an emotional state to carefully process your investment options, you need to wait.”
Jones advises clients not to rush into investing their money in annuities or other investment vehicles until they can carefully research them.
“Many annuities have a surrender period, which locks you in for a certain number of years, and if you change your mind within that surrender period you will pay significant fees,” she said.
Instead, Jones encourages recipients of life insurance settlements to keep those funds in the account that the insurance company provides or to put inheritance funds in an FDIC-insured banking account, sitting in cash, during the emotional cooling off period.
She admits there’s a small opportunity cost of not investing the funds right away, however “when you’re talking about a large sum of money, even small mistakes can be very expensive, so it’s better to be careful and wait until you’re able to make informed investment decisions,” she says.
For those who inherit or win $1 million or more, seeking the advice of a certified financial planner is even more essential, Jones said, since assets at that level immediately qualify the recipient as an “accredited investor” as defined by current U.S. Securities Law. Accredited investors are open to solicitations of certain types of riskier investment opportunities that are not made available to investors with less personal wealth.
People who fall into this category will likely be “bombarded with solicitations,” Jones said. “And just because you win the lottery or have a sudden inheritance, doesn’t mean you suddenly have the financial foundation to navigate those offers. Without proper guidance, you can quickly get yourself into all kinds of trouble.”
Get good professional tax advice
To avoid these kinds of financial missteps, Stephanie McGehee-Shacklette, an attorney specializing in estate planning with the law firm of Kerrick Bachert Stivers PSC in Bowling Green, encourages clients to call a certified public accountant immediately after learning of their financial windfall.
“The very first call should be to a qualified, certified public accountant who has a strong understanding of income tax, estate and gift taxes, and generational-skipping transfer taxes as well. In all of these various scenarios – whether it’s the lottery or an inheritance or other payout – there are likely going to be some sort of immediate tax implications, which will depend on the source of the fund and how it’s set up,” McGehee-Shacklette said. “An accountant will be able to help you with that.”
Then, within a month or two, the windfall recipient should work in tandem with a certified financial planner and an attorney specializing in estate planning to make updates to their will and to begin looking at establishing trusts for the recipient’s beneficiaries, she said.
“There are many types of trusts out there, some of which provide tax benefits, which is a good option if you want to minimize the tax burden for your beneficiaries upon your death. In many cases, though, you’re not going to want to give your children or grandchildren a large sum of money outright, so the estate planning attorney can help set up trusts or other vehicles that can transfer the wealth over time,” McGehee-Shacklette said.
Then, the third and final step, McGehee-Shacklette advises, is working closely with a certified financial planner to allocate how best to use the funds and invest them.
For McNay, the secret to maximizing a sudden windfall comes down to a simple truth: He encourages his clients to pay for experiences, not for things.
“If you go out and buy a fancy car, within a few weeks you’re going to get tired of it. Instead, use the money to make memories. Take a trip. Get involved and give your money back to causes you believe in.” n
Robin Roenker is a correspondent for The Lane Report. She can be reached at [email protected]