Inheriting a big lump of money is not without its pitfalls, including risky tax solutions and over-generous gifting.
Winning the lottery or coming into a large inheritance may seem like a dream come true, but if you’re lucky enough to receive a lump sum there are some simple financial planning rules to follow to make sure the money lasts.
Not rushing into decisions and giving yourself time to find out what you want to do with the money is crucial, according to independent financial planner Duncan Glassey, a partner at Wealthflow LLP.
Wealthflow deals with a number of clients who have unexpectedly come into large sums of money. Before offering financial planning advice, the firm recently introduced life coaching sessions to clients to help them establish what is truly important to them, the dreams and ambitions they have put off, their interests and passions, and crucially what they want their lives to look like.
It is only after the coaching programme that Wealthflow will then work out a financial plan for the client.
‘Speaking with a coach that is not qualified to give financial advice means we do not go straight into the numbers,’ Glassey said. ‘If the sum of money is large then it buys them time to look at their life afresh, and then we build the money around those objectives.’
Pay down debt
The first objective should always be to pay down any outstanding debt, whatever the size of the windfall you receive and whatever dreams and ambitions you want to fulfil with the money.
‘When you’ve established your goals we suggest paying off debt – credit cards first, then personal loans and then mortgages in that order,’ said Glassey, although he warned that if you go into a bank with your lump sum you probably won’t receive that advice.
‘Historically banks have not been good at giving that simple but quality advice because they make money by you being in debt. And additionally the banks want to sell products with commission or structured product where costs are hidden,’ he said.
Glassey then recommends setting aside a cash reserve that will help you reach short-term goals over the next five years.
Invest the rest
After paying off your debt and keeping a bit aside, you should look at investing in a diversified portfolio of funds. Glassey favours passive funds, which follow a stockmarket index by investing in a basket of representative stocks; these will rise and fall in line with the market they follow.
‘Invest in a diversified portfolio that is low cost – we invest in institutional passive-style funds. We are opposed to active, heavily traded, high portfolio turnover management,’ Glassey said.
‘There are lots of hidden costs [within active management] but more and more we are seeing fund managers charging performance fees when we think they get paid enough.’
Glassey said clients are often more interested in ‘achieving a lifestyle rather than having a sexy investment that may do well but is risky’.
Those who have come into a significant amount of money often do not need to take too much risk. Wealthflow uses cashflow modelling to plot how long your money will last while also taking into account events that may happen along the way, such as the need for long-term care.
Quite often the money just needs to keep pace with inflation rather than grow substantially, Glassey said.
Also look at the most tax-efficient ways to invest, make sure you set up an individual savings account (ISA) and make the most of the £11,280 tax-free allowance and utilise all your capital gains tax allowance of £10,600 a year.
Glassey said that he warns people off two things: ‘putting all their eggs in one basket and exotic or high-risk tax solutions’.
Giving money to friends and family may be tempting when you have come into a lump sum, but Glassey recommends waiting before promising anyone anything and see how much you have to play with.
‘We would use cashflow modelling to show the impact of gifting money. Some people are just too generous, and think if they have £1 million they are millionaires and can lead a millionaire lifestyle. But by the time they have upsized their home and their car and paid off their loans that £1 million is often whittled down to £400,000 or so and you can’t live a millionaire lifestyle on £400,000,’ said Glassey.
He said it takes 18 months to two years to become adjusted to your new-found wealth, and in that time people are ‘settling in and getting comfy with this new money’.
‘There is the tendency to be over generous, but before making promises live with the money for a year or 18 months before making a decision,’ he said.
‘When we do the cashflow modelling and show them how much their money will generate throughout lifetime people are often astounded that £2 or £3 million does not go as far as initially assumed,’ Glassey said.
‘A number of my clients who come into larger sums are in their 40s, but they have to remember with inflation £1 million in “our day” is not £1 million in today’s terms. Being a millionaire is not a big deal, a couple of million will not give them the lifestyle they think it will, you may not even be able to give up work.
‘It’s only if you want to live large for five years and blow it all that £1 million will let you live the millionaire lifestyle.’
The last piece of advice Glassey gives is to get independent financial advice: ‘Research by [lottery operator] Camelot showed on average if you did not get advice after winning than the money only last five years.
‘People need someone boring like me to bring them back down to reality!’
by Michelle McGagh
The Lolly… simple advice on growing your money