Plan carefully if you win the jackpot

Wednesday, October 28, 2009

Picture this: you've just won the lottery or received a large inheritance. You start daydreaming about all the wonderful things you'll buy and all the vacations you'll take. Money will no longer be a worry.

Unfortunately, it may not be quite that simple. If you don't properly plan on how to receive your windfall and invest it wisely, you could find yourself not on Easy Street, but on the road to financial disaster.

If you suddenly find yourself rich overnight, here is some advice you may want to consider before buying that new sports car and quitting your job.

Take lottery winnings in a lump-sum. If you're disciplined enough not to spend the money all at once, you may want to consider taking all the money at once. Typically, receiving a lump-sum will give you more money over your life expectancy than if you take the money in payments over the years. For example, if you receive $1 million and pay half of that in taxes, you'll end up with $500,000 to invest. At a hypothetical 10 percent rate of return, your winnings would have an opportunity to grow to more than $3.3 million in 20 years.

By comparison, if you choose to receive the $1 million windfall in 20 annual installments of $50,000 and invest each year at that same 10 percent, you would end up with approximately $2.8 million, a difference of more than $500,000. The more money you can get invested right away, the better off you could be.*

Choose the installment option if you're a spendthrift. If a bank account with a lot of money in it is too tempting for you to handle, take your fortune over a period of several years. You may not have this option with every type of windfall, but if you happen to win the lottery, the lottery sponsor may invest your winnings for you. You may be getting a better rate of return by taking the money in one lump-sum, but that's no use if you end up spending all of it without planning.

Keep income taxes in mind. Most likely, about half of what you win or inherit will go to pay federal and state income taxes. And remember, a multimillion dollar payout will put you in the highest federal tax bracket at 35 percent. Add state income taxes to that and you may be up for losing half of your money to taxes.

In cases where winning lottery tickets are purchased outside your home state, it's possible that you would be taxed in your home state and the state where you purchased the ticket. Careful tax planning can help you keep as much of the money as possible.

What happens when you die? If you're married, the money typically may be transferred to your spouse free from any estate taxes. However, if the amount totals more than $2 million this year ($3.5 million in 2009) and your spouse is also deceased, your heirs will have to turn over as much as 45 percent of that money to the federal government in the form of estate taxes.

As you can see, without careful planning, a financial bonanza could become a nightmare. A financial advisor can help you make sure to take the appropriate steps to help you manage the windfall more effectively.

*This example is for illustrative purposes only and does not reflect the performance of any specific investment. There is no guarantee you would be able to obtain a consistent rate of return.

Wells Fargo Advisors / Wells Fargo Advisors Financial Network does not give tax or legal advice. Specific questions on taxes as they relate to your individual situation should be directed to your tax advisor.

This article was written by Wells Fargo Advisors and provided courtesy of Terry R. Campbell, Branch Manager and Senior Vice President - Investment Officer in Chardon at (440) 286-2553.

Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.