The relative size of the financial windfall will dictate your response
When we work with clients to plan their financial futures, we ask them about expected inheritances. Although it is a sensitive subject, logic suggests that it doesn’t make a lot of sense to unduly constrain your lifestyle now if it’s known with a high degree of confidence that a substantial inheritance will be received in the not too distant future.
Our experience is that most clients tend to underestimate the size of inheritances and delay the timing of expected receipt until well into the future. There is a natural tendency not to rely on the death of someone close to sustain your financial plan.
As a result, when a larger and earlier than expected inheritance or another form of financial windfall (e.g. a lottery win) are received, it requires some emotional and financial adjustment. The amount of adjustment tends to vary with the size of the windfall relative to current net worth. We have identified, very roughly, three categories:
- Windfall less than 25% of current net worth – the windfall is relatively easily absorbed within current financial planning and is unlikely to lead to any major lifestyle changes;
- Windfall between 25% – 100% of current net worth – a windfall of this size tends to open up some possibilities that may not have previously been contemplated, such as working less, spending more, providing support to others. However, significant lifestyle changes don’t usually follow; and
- Windfall greater than 100% of current net worth – a windfall of this size may enable some fairly substantial changes in lifestyle including upgrading the family residence, changes in work arrangements and more gifts to others.
Major financial windfalls may require significant emotional adjustment
We are often one of the first that clients talk to on receipt of their windfall. Our advice is essentially:
- Only tell those closest to you of the windfall and, desirably, only your closest partner. Don’t tell your children. It is best to not raise anyone’s expectations or influence the way they may react to you until you have had the opportunity to get used to the idea of increased wealth. Most people initially have mixed feelings that they need to work through and it is best to avoid any external pressures; and
- Don’t do anything of financial substance immediately. Take the time to understand the implications of the windfall for your future and explore the possibilities that are likely to give you the greatest long term satisfaction.
Part of the adjustment process involves revisiting your financial plan. A number of changes may result, but there will be two areas that, almost certainly, will require some reassessment:
- Your current asset allocation will change, possibly significantly. In a number of cases we have seen, a large component of the inheritance comes as an Australian share portfolio. If this is the case, the beneficiary’s portfolio will become more heavily weighted to growth assets. However, if the windfall results from a lottery win, for example, the cash received will increase the portfolio’s defensive asset holdings.Either way, the windfall will necessitate re-consideration of both the future appropriateness of your current target asset allocation and how you will transition to any revised target asset allocation; and
- Your current risk protection will need to be reviewed. In most cases, a windfall is likely to reduce the requirement for life and disability cover. However, the amount of any adjustments to current insurances should reflect proposed changes to lifestyle that are in response to the windfall.
Large financial windfalls should be handled wisely
Objectively, the receipt of a major financial windfall should be something to be happy about. But our clients’ experiences suggest that there are some significant issues to come to grips with.
In the case of a larger than expected inheritance, the financial gain is offset by the emotional grief of losing someone who cared significantly about the beneficiary. Also, the more people that know about the inheritance, the greater the likelihood that there will be some who also expect to benefit and apply implicit and, perhaps, explicit pressure on the recipient.
If the windfall is relatively large compared with your current net worth, it may initially undermine satisfaction with what you have achieved to date from your hard work. In addition, it may give rise to unrealistic changes in lifestyle expectations that will need to be tempered before they get out of hand.
The competing emotions that a large windfall create suggest that the best immediate response is to change as little as possible. Get used to being wealthier and the possibilities that brings. It is our view that it is only after you have satisfactorily addressed the emotional issues and reworked your financial plan that you should make any lifestyle changes of consequence. A windfall should be handled wisely.