Prize Winnings Call for Planning

Last Updated Oct 14, 2011 1:17 PM EDT

For some people, getting a sudden windfall of money they are not experienced in dealing with can come with as many problems as it appears to solve. Here are a few planning pointers to run through if you suddenly get a lump sum of cash that is more than you are accustomed to dealing with:

Plan for Taxes:
Some lump sum payments are not subject to income taxes, such tax refunds (unless you claimed a deduction for the taxes in prior years), gifts and inheritance and life insurance benefits.

But payments for severance, bonus, proceeds from the sale of a business or real estate, lottery or prize winnings, payments from court awards and proceeds from the exercise of stock options are all generally includable in income in the year received. Think that one million dollar prize won by Survivor winner Richard Hatch would have set him for life? Think again. He is faced IRS charges for failure to pay taxes on that prize money. The taxes can be as much as half of the prize amount and interest and late payment penalties can amount to another third.

Some people are surprised to learn that non-cash prizes are taxable. When Oprah gave away Pontiacs to her audience members, the winners learned quickly that "free" prizes, were not in fact really free. Each recipient had to pay income tax on the value of the car they were given.

Anyone who receives a lump sum payment should first consult with an accountant or tax attorney. What you need to know is if the payment is taxable, how much are the taxes that will be owed, when they need to be paid and how much of the lump sum needs to be set aside or reserved to pay the taxes. Remember, the IRS will not accept "I did know I had to pay!" as a defense and getting into trouble here can cost you thousands of dollars in penalties, fines and even jail time.

Don't Make Long-Term Decisions Quickly
People who receive large one-time payments should take anywhere from six months to a year before making any long term decisions and changes that involve money. The guideline is that the larger the amount received the longer the time to make decisions. This gives someone time to think through all available options, some of which can be new and unfamiliar. That's not to say that certain decisions that are clearly beneficial, such as paying off high interest rate debt, should not be done, but avoid bigger financial decisions such as selling a home, quitting a job or making long term investments until some "cooling off" time has passed and all options are carefully considered.

Make a Safe Deposit
One of the first questions asked by people who receive a check for a large sum is, "What do I do with this check?" The best course of action is usually to make a bee-line to your bank and deposit the check. This is to ensure that the funds are cleared and credited into a financial account safely and quickly. After that, depositors need to know that their bank account balances are insured from bank failure by the Federal Deposit Insurance Corporation for up to $250,000 per uniquely titled account per bank. For amounts at one insured bank totaling more than $250,000, different ownership categories of accounts are separately, so you may qualify for more than $250,000 in coverage at one insured bank if you own deposit accounts in different ownership categories. This will apply to accounts titled separately in each spouse name and jointly. Also, some banks may tell you to deposit your money into their insured money market account, or IMMA, as this may currently pay a higher rate of interest. These money market accounts, unlike money market mutual funds in brokerage accounts are still insured under the FDIC.

Get More Interest
The next step is to check out higher interest rates for your cash while you are taking time to consider longer-term financial decisions. Check out the interest rates offered by other banks and credit unions. Also check out interest rates at brokerage firm's money market funds.

Make No Promises
When very large amounts of money are received, don't casually promise to buy anything or give anyone any money. Your newfound wealth will be a lightning rod for attracting attention of family and friends to everything you say or do. If you don't deliver on a promise, you may find yourself on the receiving end of another person's lawsuit claiming breach of an agreement or contract. It's better to keep your lips zipped about your generous intentions and surprise family and friends with your with your generosity than to become the recipient of hostility because your expressions were taken more seriously than you intended.

Strengthen Your Safety Net
When suddenly coming into very large amounts of money, you not only have more money but also have more to lose. Increase your liability coverage by purchasing an excess liability insurance policy and coordinating the coverage with your auto and homeowners policies. Increase your personal property coverage to ensure coverage for any new automobiles, homes and property you purchase. Some advice also given is to purchase a security system, hiring a security guard for a period of time and even purchasing kidnap and ransom insurance to protect you and your family from potential risks that come with becoming suddenly wealthy.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.