Lucky’s the client who gets a big influx of cash. But what should they do with it?
Whatever they do, advisor say, clients should first take some time to think about it.
“Typically, found money is easier to spend than to save,” said Duncan Campbell, partner and leader of Baker Tilly’s private wealth practice and individual market vertical, based in Dallas-Plano, Texas. “I advise them to wait a year before they spend any of it.”
“The biggest mistake when coming into a large amount of cash would be to emotionally rush into an investment that you don’t really understand,” said Marshall Nelson, wealth advisor at Crewe Advisors in Salt Lake City. “Jumping into an investment quickly for the purpose of avoiding it sitting in cash can be a mistake.”
“Never say never, but urgent trading and investment activity rarely fit a diversified, long-term investment strategy,” said Brian Hungarter, vice president and wealth advisor at Girard, a Univest Wealth Division, based in King of Prussia, Pa.
“We tell our clients to anticipate the liquidity event and plan ahead. ... Not only from an income tax perspective, but also overall for charitable, gift and estate tax planning, it is important to plan ahead,” said Varun Vig, a director in the Personal Wealth Advisors Group and a member of the Financial Services Group at EisnerAmper in New York. “In the year of the liquidity event it’s very important to understand what’s subject to ordinary income tax and what’s subject to long-term capital gains.”
A good financial plan is the best guidepost. “For example, money in a brokerage account that’s earmarked for an upcoming home purchase can be invested a lot differently than money in a Roth IRA that will be passed down to a client’s kids,” said Tyler Sterk, a wealth advisor at Kayne Anderson Rudnick in Los Angeles.
“We typically recommend dollar cost averaging into the market,” said Bruce Primeau, a CPA and president of Summit Wealth Advocates in Prior Lake, Minn. “The first step we advise is to set aside some of that windfall for anticipated income tax to be paid. Another important step is to prepare an income tax projection.”
“Currently, we’re in a situation where short-term returns on fixed assets are higher than on comparable long-term fixed assets,” said Steve Parrish, adjunct professor and co-director of the Center for Retirement Income at the American College of Financial Services in King of Prussia, Pa. “The client can consider taking some of the proceeds and putting it into a fixed asset with a short maturity. A one- or two-year CD is currently generating a competitive yield. A similar approach that may generate additional yield and defer taxes is a multiyear guaranteed annuity.”
“Assuming the client has maxed out qualified account contributions, consider investing in an after-tax IRA. It can be converted later to a Roth IRA,” Parrish said. “They should consider converting deferred retirement accounts to a Roth IRA and using their newfound liquidity to pay the additional tax created by the conversion. The client will have money in the market, but on a tax-free basis.”
Vig added that the charitably inclined client should consider a donor-advised fund. It “gives you a current tax benefit for the amount contributed and it grows tax-free until you’re ready to donate,” he said.
“Clients are able to get a dollar-for-dollar tax deduction in the year they make a cash contribution to their DAF,” Nelson said. “In a year where a client has much higher income, it can help them immediately to defer some of the income tax.”
Other good vehicles, Vig said, are U.S. Treasurys or state municipal bonds, as well as qualified small business stock and qualified opportunity zone funds.
Primeau recommended 529 accounts or Roth IRA contributions for children or grandchildren, given the tax-free nature of those accounts.
For clients with an itch to put money to work, Campbell said, “There are bonds, CDs and money market accounts that can provide returns while they pause and think."