Maximizing Financial Windfalls: Avoid Mistakes with Inheritance, Stock Liquidity, or Business Sale

Join us on the Complete Wealth Management Podcast, Episode 19, where Certified Financial Planners and Tax Experts Dave Alison, Conrad Levesque, and David Roth delve into considerations, planning, and strategies for a sudden financial windfall. Whether you’ve received an inheritance, sold a business, or cashed out stock options, this episode provides essential considerations for managing your financial windfall.

➡️ Key Topics Covered:

1. Retirement Planning: Explore how to make the most of your newfound wealth while securing your future.
2. Tax Management: Understand the tax implications of your windfall and strategize accordingly.
3. Creating Cashflow: Learn how to generate income from your assets to sustain your lifestyle.
4. Inflation Impact: Consider the long-term effects of inflation on your income.
5. Legacy and Charitable Planning: Discover ways to leave a lasting impact through philanthropy.

Join us as we unravel the complexities of financial windfalls, debunk myths, and provide evidence-based insights. Whether you’re a seasoned investor or new to wealth management, this episode offers valuable guidance.

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Advisory services are provided through Prosperity Capital Advisors LLC (“PCA”) an investment advisor registered with the United States Securities and Exchange Commission (SEC). Views expressed herein represent the opinions of PCA and are not intended to predict or depict performance of any particular investment.

All data provided, including any reference to specific securities or sectors, is provided for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation, or recommendation to purchase any security. Consider your investment objectives, risks, charges and expenses before investing. These views are as of the date of this publication and are subject to change. Past performance is no guarantee of future performance.

Transcript

Speaker 1: 0:00

Hey everyone, welcome to the Complete Wealth Management Podcast. I'm Dave Allison and, as always, I have Conrad and David Roth joining me today. What's up guys? How you doing? I'm doing great. How are you Doing good, conrad? Tax season is over.

Speaker 2: 0:15

I was going to say, I have a whole new outlook on life. I feel like it's a Disney movie today. Tax season well, the first part of tax season is over. The busy April 15th deadline is coming on. I feel like it was actually a pretty good year, so obviously I'm feeling much better than I was three weeks ago.

Speaker 1: 0:33

Well, in today's episode we're going to talk about some common mistakes that we see people make when they have some sort of like sudden wealth, liquidity event or you know financial windfall that comes into their life. And really the genesis of today's podcast episode actually came from a conversation in a client meeting that the three of us had last night with one of our clients who was with a tech company that you know. News just broke that IBM is purchasing the company, and so typically what we see in an event like that is that the company acquiring the other company cashes out all the stock and the stock options, and for many of our clients at least our clients in the Silicon Valley area they're heavily compensated with stock and stock options, and so this is not our first rodeo. We haven't really seen too much big M&A activity in the market downturn that we saw in 2022 and even in 2023. But we were certainly running into this in 2019, 2020, 2021. Running into this in 2019, 2020, 2021.

Speaker 1: 1:51

And we've been through this experience where maybe a client of ours has stock options or restricted stock units and we're thinking about long-term planning when it comes to this money and it's going to have a vesting schedule over time. So it's not really their money until it actually vests. And then all of a sudden news breaks and ABC company is going to buy XYZ company and all that stock gets cashed out. And it's interesting because it's a big liquidity event but needs to happen, as we're going to talk about in this episode today, because maybe you're not going to have a job at that parent company, maybe you don't want to go work for that parent company, maybe you've got enough money that you don't have to work and it's now a more work optional lifestyle, or you want to pursue something different.

Speaker 1: 2:42

And I think what we're going to talk about today could really transcend not just like working at a company that gets acquired by another company, but it could also be in the form of maybe you've received an inheritance. One of our clients is in their early 60s, mom and dad just passed away and they've received an inheritance that allow them to now potentially walk away from work. And how do you think about that? And in other cases I know guys we've worked with business owners that have found an opportunity to sell their business and we'll talk a little bit about mistakes that some business owners make leading up to a sale and then post-transaction. So a lot of this could really be for clients that maybe are working at a company that could potentially sell. It could be for individuals who are going to have some windfall like an inheritance and they want to think about how that is factored into their plan. Maybe it's a business owner who wants to cash out in the next few years, and so a lot of fun stuff we'll jump into today.

Speaker 2: 3:55

Well, guys, I'm excited to talk about this topic. I think there's so much that we can do to unpack, you know. I first want to throw out a question to you guys, right In working with clients, what have you seen and we have a lot of clients, I would call them high performers what have you seen as the biggest challenge or biggest struggle with conceptualizing what retirement and I'm going to put that in quotations would look like if it's considered early?

Speaker 1: 4:23

Well, I'll kind of just kick things off. I mean, you know you mentioned earlier that a lot of the clients that we work with you know would be, you know, high performers, high level. They're very driven people. You know they're either leadership team executives, engineers, business owners, lawyers. You know doctors, those types of professions and my first question is always like well, why do you want to retire?

Speaker 1: 4:51

How would you define retirement? Is it you just don't want to have a nine to five that you're accountable for and showing up and working for somebody else? Is it that you want to just go play golf and fish and travel every day? Or is it you want just more of a work-optional lifestyle where you're actually not going to retire from working? You are going to continue to work, maybe do consulting, maybe help advise on startup companies, maybe go generate some part-time income, but you're going to retire from the nine to five of what maybe you've been doing for the last five, 10, 15, or 20 years. And so I think that when we think of this windfall or liquidity event, what it really does more than anything is it gives people options and flexibility, depending on the dollar amount.

Speaker 1: 5:42

If you inherit $100,000, that's great. It's going to help your financial plan, probably not going to change your life. If you're 40 years old, you can't retire on $100,000. If you inherit $5 million, that could potentially change the game in the course of what decisions that you make. And very similarly to if you were working at a company and that company gets acquired and your stock options get cashed out, what's that dollar amount? And is it what I call FU money, where you can walk into your boss and say, fu, I'm done here because I've got enough assets to support my lifestyle for as long as I live? Or, you know, is it more like, hey, we're a little bit more comfortable now, but I don't know if I have the assets to sustain my longevity.

Speaker 2: 6:33

So, david, you wouldn't necessarily advise every client to stop working and then go be a greeter at Walmart, right?

Speaker 3: 6:42

Not, unless that's what you love to do and you have enough money to do it. Okay.

Speaker 2: 6:46

So let's talk about that. You hit a word that I always ask my clients of love right? What makes you feel good, and how do you translate that into what's next? Because retirement oftentimes is a bad word or a dirty word, right In this context. So talk to me about how you talk with clients, about how they get to explore some of their feelings, and then how we translate that into the what's next conversation.

Speaker 3: 7:12

Yeah, and a lot of it is. As Dave Allison mentioned. What are your options? Can you live a work optional lifestyle or are you going to need to continue to work? What are the things that you need to do, and can you actually do that with this particular windfall? So I think that's one of the important key parts here.

Speaker 1: 7:32

Well, and you know, conrad, I think it comes down to like what your expectations are too. So you know, I'll run through a couple examples, and I again I think we keep throwing out this term like retirement. But let's say, you come into this sum of money Again, it could be through a number of different avenues. You decide to sell your business and decide it's time to walk away, or you get a bunch of stock options that get cashed out, or you get an inheritance, and there's this whole actually financial movement. You guys are probably both familiar with it it's called FIRE and it's this whole mindset of try to save as much money as you possibly can, build up this financial nest egg and then be financially independent and retire early. And a lot of times when I see people who embrace that approach, it's like you got to live as frugally as possible and, quite honestly, that might appeal to some people. Other people might be like I want nothing to do with that. I work really hard, I have the ability to make good income. I'd rather be able to enjoy some nicer things than to have to live incredibly frugally just to be retired per se, and so I think everything comes down to this cash flow conversation.

Speaker 1: 8:52

We just had a meeting with one of our clients last night and this whole situation came up where they work at a company that it was just announced they're getting acquired by IBM HashiCorp was the name of the company. So if there's any other HashiCorp employees listening and you need help with this, we got a team that can certainly help you strategize and think through this. But, just like most other company acquisitions, the reality of it is all the company stock that those employees had in HashiCorp is going to get cashed out. They're going to have a liquidity event. They're also going to have an income tax event, which we'll talk about throughout this podcast episode today but they're going to have a pretty nice sum of liquid money for whatever their stock options and RSUs were worth.

Speaker 1: 9:38

And so the question then comes into okay, I have this pile of money, how do I translate that into an income stream? And, more importantly, how do I translate that into an income stream that accounts for inflation and accounts for me not running out of money when I'm in my 70s, 80s or 90s? Because if we ignore the last few years of inflation, that it's been really high. If we look at the long-term average of inflation, it's been around. Let's call it 3%. And so what that says is about every 16 years your income needs to double to keep up with the cost of goods and services.

Speaker 1: 10:24

And so if you're accustomed to living on $150,000 of cash flow today, and let's say you're 45 years old and you have this liquidity event like your company stock or you sell your business or you get an inheritance and you're asking like hey, do I have enough to actually stop working the first thing is well, if you're living on 150 today, that's going to be about 300,016 years down the road. It's going to be about $600,000 32 years down the road when you're in your mid 70s at that point. So you need to have a game plan to not just think like I need 150 grand a year. You need to think about the impact of inflation, because a lot of times when we do traditional retirement planning, I mean what's the most common age people retire, guys? 65. Yeah, okay, let's call it 65, 66, 67. I'm seeing a lot more 70 year olds because they're enjoying what they're doing right now and they're making good money. But let's say it's 65. What's the typical life expectancy of a human being right now in the United States?

Speaker 2: 11:34

Let's call it 80 for males. I think the last one I saw was somewhere between right around 80 for males, 82 or 84 for females.

Speaker 1: 11:42

Okay, so let's say 85. Let's be generous. Our clients have money, they have good access to healthcare nutrition and they exercise and take their vitamins right. So for the traditional retiree they really need to account for about 20 years of inflation adjusted income.

Speaker 1: 11:58

But as you dial that scale back and now you start talking about retiring in your 50s or your 40s or you know, hey, maybe even earlier we had a client. Well, we have a client. I shouldn't say we had a client, I sound like he died. We have a client who retired at 27. Right, think about the longevity of what his inflation adjusted income stream needs to be able to do to support his lifestyle, and his assets need to account for that.

Speaker 1: 12:24

So you know, the first question that we would typically ask when you have a windfall of money like this and you want to potentially retire, is we got to get kind of laser focused on your cash flow? How much do you need to cover your living expenses? And are there going to be what I would call chunky peanut butter components of your cash flow? Maybe the first five years make is they decide to retire. They think they have enough to be able to last them. They find out in fact they don't. And then five, 10 years later they're out looking for work, and when you leave the workforce and you have a 10 year gap, it's hard to find anything that maybe you would have been accustomed to 10, 15 years ago, right? Especially like with some of our clients in Silicon Valley, I don't know of any major tech companies that would hire somebody that's been out of the game for a decade and potentially compensate them at the same level they were when they were in the weeds nine to five.

Speaker 3: 13:39

Yeah, and that's a really key point is what your earning potential today might not be the same thing 10 years from now if you take off 10 years.

Speaker 1: 13:48

So just to really be cognizant of that, so, conrad, when people think about cash flow, one of the things that I don't think they have a good comprehension about is, if they retire before the age of 65, what are two big things that they need to account for in their cash flow and their finances?

Speaker 2: 14:06

Yeah, I'm going to go with the smaller one likely first, which is healthcare, and I know you're thinking that's the smaller one, but most people and including the conversation we had last night you think about what you get as a company benefit and now you have to pay 100% of that on your own. Now, outside of government subsidies, that could be for a husband, wife and maybe two kids, $25,000 a premium a year. Right, have we seen those premiums most recently? Absolutely. That doesn't include covering the actual cost of your medical care. So medical is a huge expense.

Speaker 2: 14:44

The second one is taxes. Right, and you think about you earn W-2 wages. You go to your job nine to five. They pay you for income. Right, retirement accounts are not available prior to 59 and a half without paying a 10% penalty on top of taxes. So we have to think about where your income is coming from and the potential for taxes in the long term and how they play into what you're going to have. You're no longer having those withheld from a W-2 job. You now have to pay them out of your normal cash flow.

Speaker 1: 15:20

Yeah, and I would say just from a planning standpoint, there are some strategies that we help clients navigate in thinking about how to potentially generate some healthcare tax credits to offset the cost of healthcare, depending on how we structure their income sources. And then also with the retirement accounts you mentioned, they can't really touch it until age 59 and a half without a penalty and there's some unique planning. You can do a strategy called a 72T distribution. We're not going to get too into the weeds today on those strategies that are available to people, but there are some options. But what we see is healthcare is still a huge expense prior to age 65.

Speaker 1: 16:05

And if you are able to tap into some of your qualified retirement money, it's generally a pretty small amount in terms of what you actually need to sustain your lifestyle, which is why, when we help clients build these accumulation plans, it's so important to diversify your taxes right.

Speaker 1: 16:24

Have money in qualified retirement, have money in Roth accounts, have post-tax money that again you could utilize to supplement your lifestyle, your income needs, if you decided to stop working early. And the reality of what we see is most of our clients who get a financial windfall again, whether maybe they're selling the company or they're cashing out a bunch of stock and stock options is most of that money is after tax, which is helpful in constructing a more tax efficient retirement income distribution strategy for them in retirement. Now if you're inheriting money, that could be a whole different story, because we've had clients that have inherited their parents' pre-tax retirement accounts and with those it actually crushes their income tax planning because they're forced to distribute those accounts over a 10-year time period and it's all taxed at ordinary income and so inheriting a retirement account could actually push you up into some of the highest tax brackets out there and erode a lot of that wealth to excessive taxation. And I know we have a lot of strategies we talk to clients about regarding tax management and tax planning around inheritances.

Speaker 3: 17:42

Yeah, and Dave, one thing that I'm thinking back to and as we talk about these plannings, is charitable giving and if you have a windfall, how does charitable giving play into this? And I know we had a great podcast about with Christopher Worley and maybe you can give some insight into how that might impact in the year that you have a windfall.

Speaker 1: 18:02

Yeah, 100%. I mean I think there's some different things to think about and it depends on where in the spectrum you are of your charitable intent. We have some clients that have been fortunate enough to amass a fortune and when they do decide that enough is enough, they're going to actually not really focus on sitting on the golf course or sitting on the boat, fishing or traveling. They want to actually redirect their energy and talents from maybe building a company or running a company to helping different charitable causes. And so in the year you have these bigger financial windfalls, that's really the best time to start funding what I would call your charitable fund, to make future donations from later on in life. And there's a lot of great tools. There's donor advised funds, there's charitable trusts, there's private foundations. Those are all ways that you can start to segment a part of your net worth or assets into your charitable vision, but recognize the tax benefits.

Speaker 1: 19:14

In the year you have this big liquidity event. Now for other clients, they might not have this big philanthropic or charitable intent, but they do give to charities and they want to continue to give to charities. And so even a more modest donor advised fund for example, the client that we were working with last night has some individual stock that's vested in their company. It's appreciated in value when the company cashes it out. There's going to be a long-term capital gain associated. It might make sense to shift a portion of that stock into a donor advised fund, Because if we're now holding a portion of that company stock that's got a bunch of appreciation in it in the donor advised fund and then those shares get cashed out, how much tax does the client pay? They don't pay any tax.

Speaker 1: 20:03

Yeah, that's right. They don't pay any tax because the shares are held in the donor-advised fund. When they're liquidated, the donor-advised fund doesn't pay tax. And what else does the client get by moving some of those shares into the donor-advised fund?

Speaker 2: 20:17

At the time of donation, they get a charitable deduction on their tax return.

Speaker 1: 20:21

They get a charitable deduction and that's probably in the year that they're gonna have one of the highest incomes of their entire life. And so, again, if you're having a liquidity event, selling a business being cashed out of company equity, you know these are the times that we sit down and say, all right, let's think about if you do have any charitable intent. We want to be able to kind of make hay while the sun is shining. We want to be able to maximize these deductions in the year that you're going to be in that top 37% tax bracket and create the deductions, get your charitable fund set up and then you could make the gifts to charity for the next 10, 20, 30 years. You don't have to do that this year, but at least it recognizes the deduction. So, in terms of bringing a lot of this stuff together, I think that the overarching mistake and pitfall that we see people make is they don't engage in planning right. This is all just planning 101 that we're talking about right now. It's really planning around what your goals and objectives are right, what your desire is.

Speaker 1: 21:28

For me, I don't know if I would do well in retirement. I love working, I love being involved in building things and helping people and maybe there's some form of retirement. I could still get all of that satisfaction. But if I inherited $20 million tomorrow, I don't have any plans to do that, unless anyone wants to add me as their beneficiary. I'm happy with that. But if I did, I honestly don't think I would materially change much of what I'm doing in my life right now. I love the work that I do. I feel like I'm in kind of the peak of my career of being able to continue to help other people navigate their own finances, and I think many of the listeners on this podcast probably feel the same way. It's not about the money. They don't go to work for the money anymore. They go to work because they're making an impact and they're passionate about what they do. But planning starts with that really identifying your passion, your goals, your objectives, your dreams, your bucket list, your vision for what the future looks like. Then it starts to go into cash flow planning for what the future looks like. Then it starts to go into cash flow planning how much do I need to be able to achieve my goals and objectives and my vision and continue to check things off my bucket list? And does that mean I stop working altogether. Does that mean I go to more of a work optional lifestyle? Does that mean I just pick up some consulting gigs and do some passion projects along the way and then it goes into planning around investment structure. What types of stocks, bonds, mutual funds, etfs, portfolios should you be holding? Because if you do decide to go more this retirement or work optional lifestyle, you go from what we call an accumulation strategy to a distribution strategy.

Speaker 1: 23:17

And if you think about just investing 101, growth and income sit on two different sides of the teeter-totter. So if you're focused on growing your assets as much as possible, a lot of times you want to minimize the impact of income from the portfolio, particularly if you're working, have W-2 wages, have a high income, because the tax man is going to take a big bite of the income while you're working. Now, when you decide to stop working or slow down or take time off, we might want that teeter-totter to change. And now our investment focus goes more towards income generation, particularly passive income generation, and we're not as focused on pure growth.

Speaker 1: 24:00

Of course we want to see our account balances grow. We need them to grow to be able to help combat inflation over time and build as much wealth as we can, but income is a consideration, I would say the primary consideration. So again, goals and objectives, cashflow planning, investment planning and longevity right, making sure that that income and cashflow can last you as long as you're alive. Taxes are a critical component, healthcare is a critical component. So it's like a game of chess. You're thinking three, four, five moves ahead, sometimes 10 moves ahead to get back to where you need to be to make these types of decisions.

Speaker 2: 24:38

Dave, you hit the nail on the head with that list, right, and I think anybody listening to this that's going through this. That's it Number one. We'll recap Understand your why, what your goals and objectives are and what you feel like is next. Number two understand your cash flow. You better make sure to think about taxes and, as we mentioned, your medical costs and then understand where you're going to get what did you say, dave, the chunky peanut butter spending right, where it's going to be chunky and lumpy and ultimately, where you're going to see big spikes. And then third is really looking at your asset allocation and location and making sure those are in line with the teeter-totter of are you accumulating or are you distributing money from your portfolio, and will it last?

Speaker 1: 25:28

Yeah, definitely. And the last thing that I just want to touch on in this episode is we certainly do have clients and potential families that we're helping that have that substantial windfall. I was just brought in on a family yesterday actually that they sold their business to private equity. They got a nice chunk of change. They got also a 17% interest in the private equity fund because of the acquisition, and the private equity fund has crushed it. And now the second bite of the apple is worth $70 million split between two brothers $35 million each, and the two brothers are in their seventies.

Speaker 1: 26:12

And so to me, that's what we called earlier FU money right, that's multi-generational wealth money. And so what happens typically and this happened in this scenario is the earlier we can start doing planning for a transaction like that, the better. We don't want to wait till a term sheet is in place or the money's about to get deposited into your bank account, because there's so much strategic opportunity from income tax planning and mitigation to estate planning, to funding multi-generational trust for the family, the kids, the grandkids, the charities that the earlier you can get involved, the better. And so I would say that's actually the last component, the charities that the earlier you can get involved, the better, and so I would say that's actually the last component of the planning when we started at the beginning of goals and objectives and vision and bucket list items and cash flow and assets and how you're invested and taxes and healthcare planning. Legacy planning is that final piece of it all. If you were no longer around, where does your stuff go? Who's in charge? What are the rules? And for a lot of our clients, they've accumulated enough money that is actually more than enough money for them during the rest of their life and they want to start thinking about how they impact other people.

Speaker 1: 27:36

Again, it could be charities, it could be children, grandchildren, it could be just setting up a generational trust that provides scholarships to nieces and nephews and cousins. It could be a trust that provides a multi-generational pool of money for people to start businesses in the family. Like there's so much cool stuff you can do when you get to that level and we help our clients think through that. But again, whether you're inheriting a more modest sum of money $100,000, $200,000, or whether you're selling your business for $70 million, there's just so many things that I know we've been able to help our clients navigate and just critical decisions and, to the point, david opened up the episode with you know mistakes that people make along the way that are big, big mistakes. I mean you know when you're talking about seven figures or eight figures of money, the mistakes could be costly. And so you know, taking your time, not being rushed, being able to understand the trade-offs associated with the decisions, are where we really spend our time educating the families that are in these financial positions. Well, any closing thoughts?

Speaker 2: 28:45

guys, mine is gonna be a repeat of what I've said in prior episodes Planning early and often means that you're prepared for what's next, and so engaging in whether it's a team like us or another fiduciary financial advisor to help you make these highly important decisions and ultimately implement that plan, I think is huge for most people. So you know, reach out, schedule a call, because I hate seeing people make these mistakes knowing we can't fix them.

Speaker 3: 29:22

Yeah, and I like going back to your chunky peanut butter analogy, it just really sticks in my mind for some reason is just to really figure out where it is, where the bumps are going to be. You know that you're going to have a big, big, big windfall now, but how is it going to play out over multiple years and it might be chunky, so just keep that in mind.

Speaker 1: 29:40

Exactly, let us help you smooth out that peanut butter. All right, fellas, it was a great episode. Don't forget subscribe to our YouTube channel, follow the podcast on every major podcast player Spotify, google, apple and we will see you on the next one tax or legal advice.

Speaker 4: 29:54

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