Smart Ways To Deal With Windfall Income

4 minsJune 05, 2017

“I believe life is a Karma Café – if you do good, all good comes back to you and vice-versa. Moreover, service to mankind, is service to the Almighty.

Entrenched with this philosophy, my wife and I engage in social work and help the needy selflessly. These values are also being passed on to our children. And let me share that it’s been quite a fulfilling experience for us, and I’m reaping the fruits - emotionally, spiritually, and even financially.

Uncle Owen, my paternal aunt’s husband, who was a seafarer, passed away at 52 of a cardiac arrest. Being a couple without children, they were fond of me and so was I. As a family, we reminisce and have the taste of the sumptuous Christmas pudding my aunt used to make with generous portions of rum, wine, plums, and prunes. Recently, my aunt passed away at 87. After Uncle Owen’s demise my wife and I looked after her unconditionally – and many of our relatives and friends are a testimony to that. One fine day, we stumbled upon a Will (found while clearing her teak wood closet) and were astonished to learn that Uncle Owen and Aunty Merissa, my aunt, had left behind assets – which included a flat in Mumbai, fixed deposits and investments in shares - in favour of their beloved nephew, Willy – that’s me as I’m warmly called by my near and dear ones”, said Mr Wilfred Fernandes, a food catering business owner in Mumbai.

Flipping the documents reflecting the approximate valuations, Mr Fernandes, age 51, had immense emotions to this windfall and wanted to deal with it productively.

Lowell Tom Perry, an American businessman and religious leader who was a member of the Quorum of the Twelve Apostles of The Church of Jesus Christ of Latter-day Saints, has beautifully said, “A good character is something you must make for yourself. It cannot be inherited from parents. It cannot be created by having extraordinary advantages. It isn't a gift of birth, wealth, talent or station. It is the result of your own endeavour. It is the reward that comes from living good principles and manifesting a virtuous and honourable life.”

Many individuals, often like to binge on all the goodies of life – buying a car, travel abroad for leisure, buying a dream home, and so on - with a windfall income. But Mr Fernandes, being thoughtful, aspired to do something more productive, more meaningful. His key financial goals were to get his daughter, Chrysel, married and later live a blissful retired life with his wife, Maria.

So, here’s the smart approach to follow to deal with windfall income…

  • Set a cool down period:
      This is the time you don’t do anything with the windfall gains. If someone challenges what’s been bequeathed, this would help. Fortunately for Mr Fernandes, there were no such worries.
    • The tax incidence is also needed to be looked into carefully. After all it’s a constitutional duty to abide by.
    • Also, it is an opportunity to revisit goals and even consider changing dynamics for prudent estate planning. So, think through carefully, and with deep-seated humility and a clear mind.
    • Fortunately self-effacing Mr Fernandes, aspired for nothing more than to fulfil his aforementioned key life goals, and of course, he wished to serve the needy abetted by the windfall gains. This is in stark contrast to what many individuals usually do – splurge on a foreign vacation, buy fancy gadget, a car, a wardrobe makeover and so on. They turn into reckless spenders, not knowing how to use the windfall gains productively. And those who invest, do it almost in an ad-hoc manner which can be perilous in the long run.
    • You see, it is essential to allow emotions pass, and not do anything that’s imprudent and immature. It’s best to stash money in a safe place – a savings bank account or a liquid fund – until you’re clear how to use the money. Resist the temptation to splurge the windfall income.
  • Boost contingency reserves:
    • Nothing in life is permanent or guaranteed. So, although, Mr Fernanades was making a good sum in the food catering business, boosting contingency reserve (which was discovered to be insufficient) to at least 6 to 12 months of his regular monthly expenses was needed, by deploying money in liquid funds.
    • One needs to plan well for a rainy day. Planning well can save you from much discomfort later. It helps ease the financial hardships one could face as result of loss of job, decline in monthly income, and so on. Therefore such newfound wealth could play a crucial role to help you and your family on a rainy day when the need arises.
  • Priorities to fulfill from a windfall income - Axis Bank

  • Insure optimally:
    • In case of Mr Fernandes, his wife, Maria was assisting him in the business. A review of his insurance portfolio revealed that he had a sub-optimal life insurance coverage. So before the goals envisioned were catered to, indemnifying risk to life with due respect to scientific concept of ‘Human Life Value’ was recommended.
    • Remember, life today is full of uncertainties. With the increasing stress and tension these days a lot of us are prone to physical and mental disorders. Therefore, it is extremely important to have an adequate life and health insurance cover.
    • So, in case you are under-insured, use a portion of the inherited funds to increase your insurance cover. For the financial security of your family, life insurance is vital when the breadwinner of the family passes away. Thus optimally insure yourself and buy none other than a pure term life insurance plan to indemnify risk to life for a maximum cost-to-benefit. Avoid commingling your insurance and investment needs; keep them separate. Similarly, given that healthcare cost is on a rise, ensure you have a sufficient health insurance cover paying heed to the medical history of your family, occupational hazards and the city/town you reside among many other things.
  • Reduce (or eliminate) the debt:
    • Mr Fernandes had taken a home loan to purchase a villa in his hometown in Goa. The outstanding amount was substantive. After Mr Fernandes received his inheritance, he repayed a portion of the debt; as he was sub-optimally insured and had family members dependent on him.
    • You see, in case you have debt lingering around, reducing or even removing it should be amongst your top priorities when you plan to utilise the windfall income. So, any obligations such as credit card dues, personal loans, business loans, etc. should be repaid, especially the ones bearing a very high interest rate. This will not only help save a lot on the interest cost, but also improve your credit score, which is considered in case you need to obtain further loans in the future. Besides, it provides a boost to your financial health and aids in achieving vital financial goals.
  • Address the important life goals:
    • There were two key life goals that Mr Fernandes had to provide for. First: funding his daughter’s wedding, and second: planning for his retirement. Being money wise, he did save and invest. But most of his investments were made in an ad-hoc fashion and predominantly in fixed deposits, corporate deposits, bonds, etc. – which are debt instruments. This would not help him to clock an appealing real rate of return and achieve his financial goals. Therefore tactically, a significant portion of Mr Fernandes’ portfolio was skewed towards equity, so that he could compound wealth at a better pace of return for his daughter’s wedding 12 years from now, and his retirement at 65.
    • Prioritising financial goals is necessary, as certain goals are not only important financially, but even emotionally, for instance: setting money aside for the daughter’s wedding, or planning a vacation with family. But along with prioritisation, one needs to ensure that the asset allocation is set right, so as to inevitably safeguard the long-term well-being of the loved ones.
  • Invest sensibly:
    • Some individuals, after a windfall, take extraordinary risk and invest all the money in risky asset classes being swayed by exuberance just because their next-door neighbour, friends, or relatives invest in it. Besides, in a world of financial engineering that we are in, one could easily get into exotic investment products, which may not always be the best fit for one’s portfolio. But all this can be hazardous to one's financial wellbeing; as food for one can be poison for another.
    • Fortunately, Mr Fernandes was wise, and most of his investments were in traditional products. He was conservative, but perhaps overlooking the fact that equity as an asset class, over the longer investment horizon, can compound wealth at a better rate of return and thus taking a little higher risk does hold merit. Nevertheless, having recognised the advantages of investing in mutual funds, he made a structural shift to his portfolio, and today his investments are well on track to achieve his key financial goals.
    • When you invest, it is vital to recognise your risk profile. Although your risk appetite might increase with a windfall income, you must observe caution while determining your asset allocation. Take cognisance of your investment objective, investment horizon and many other finer aspects such as tax angle before you invest your newfound wealth. If you endeavour to reduce your tax liability, it would be prudent to invest in tax-efficient instruments. And mind you, it is not only financial investments you must look at, but you could also focus on personal investments such as educating yourself or engaging in a hobby that can enrich your life.
  • Indulge in estate planning:
    • Estate planning in simple terms refers to passing down of assets from one generation to another. Each one endeavours that the wealth – whether self-earned and/or inherited – that is deployed in physical and financial assets, is inherited by or transmitted to person or persons whom he/she want to.
    • Estate planning prevents the addition of financial and legal grief to the emotional grief your loved ones will already be facing upon your absence. The law might not take into account personal relationships or preferences while distributing your assets if one die intestate (i.e. dying without a Will). Without proper planning, it is possible that the law disposes the estate among relatives who might not be the immediate choice of beneficiaries of the deceased.
    • Recognising this, Mr Fernandes was advised to write a legal Will, reaching out to a practicing lawyer with expertise in the domain of estate planning.
  • Spend some money to fulfil your dreams:
    • We recognise that you might also have a few personal wishes, which you dream to fulfil apart from family responsibilities. You deserve to spend a small portion of the windfall income as you wish so as to enhance the quality of life.
    • Mr Fernandes was inclined to travel for short vacation to London with his family and tender some portion to charity. So, consequent to the action points, 2% of his inherited income was opined to be expended on the vacation, but the amount for charity was undefined with due respect.

To conclude…

Earning a windfall income becomes a reality for a few individuals. Mind you handling windfall income is not easy as it seems. It is the dignity, humility, and responsibility with which one handles it, goes a long way in a very meaningful and fulfilling life.

Avoid asking for tips from friends and relatives for managing your bonanza. Every person has different goals and risk appetites. They might have a different view of living life as well. Get your advisory team: your chartered accountant, financial planner, and a lawyer with expertise in estate planning.

Don’t allow the rush of a windfall income to triumph over the prudent approach. Be sensible, invest astutely and ensure long-term financial wellbeing, before you placate your short-term gratifications.

Happy Investing!

Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinion on investing. Axis bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.