With Poor Planning, Sudden Riches Can Be Wasted

Tom has a problem that most of America would like to share. He became suddenly rich by winning millions of dollars in the California lottery.

Within hours of winning, his phone and doorbell started ringing with poignant hard-luck stories from people needing cash.

It’s never stopped. Can he finance an experimental, potentially life-saving operation? Would he save a friend from foreclosure? A few thousand dollars could clear up another’s tax problems. With so much wealth, can’t he share?

Yes, paying bills has never been easier, but the money has broken up friendships, caused family disputes and left him with troubling financial concerns. Sudden wealth leaves you with precious little time to learn the basics of savvy financial management, Tom says.

Tom’s woes, though exaggerated because of the amount of money and the publicity, are shared by hundreds of thousands of Americans who--for reasons ranging from inheritance to an early-retirement buyout--find themselves suddenly flush with cash. Whether it’s $40,000 or $4 million, people who come into lump sums that exceed their annual earnings often find themselves worrying about what to do.

The biggest mistake, financial planners say, is to spend too much too fast. If you are 40 years old today, you probably don’t want to live luxuriously or donate charitably for 20 years only to find yourself destitute--and unemployed--at age 60.

Anyone who comes into a lot of money should move slowly and think about priorities. For example:

* Do you want to raise your standard of living substantially? Maybe you should keep working and use this newfound money to make the rest of your life easier.

* Do you want more free time? Maybe you shouldn’t change your standard of living very much, instead using this cushion to let you comfortably pursue interests that don’t make money.

* Or should you compromise? Consider working part time for a while, especially if you generally enjoy your job. Or, if you’ve always wanted a different career, you now can start at the bottom in a new industry or go back to school without having to sacrifice anything.

* Take care of the financial basics. Pay off all your non-mortgage debt--and maybe your mortgage too. Make sure you have an estate plan, not just a will. And don’t take on more credit.

If your award will be made over many years, be wary of the industry of little-known financial companies that will pay you a discounted lump sum now and collect from your prize installments later, as they arrive. Some states--although not California--even ban this practice. Although such an arrangement could make sense for winners who face an emergency or want to pay off large debts or start up a business, what is in effect an interest rate on such deals--which are loans--will often be high.

Overall, the concerns of the suddenly wealthy vary based on how the individual came into money. There are three common roads to sudden wealth: You can win it. You can inherit it. Or you can get it through pension or stock option plan savings distributed to you all at once because of a job change or a retirement.

Prizewinners

By and large, the people who have the most trouble with sudden riches are those who win the money in a state lottery or in a contest such as Publishers Clearinghouse, planners say.

There are three reasons for their woes: limitations on how jackpots are paid out, lack of financial savvy and publicity.

Prize jackpots are generally paid over a period of years--usually 20 to 30--without interest. So instead of getting a check for $10 million that you could invest and earn interest on, the lottery would pay $500,000 annually for 20 years.

“If you have been living a lottery winner’s lifestyle and haven’t done anything to put money away or develop some marketable skills, you’re in for a big hurt when the money stops,” says Tom.

Then, too, contest winners are often fairly unsophisticated about what they need to be financially independent, says Tim Kochis, a certified financial planner with Kochis & Fitz in San Francisco. Consequently, they’re particularly likely to spend too much or, at the other extreme, enjoy their wealth too little.

“We had a guy who won $3.5 million in a slot machine. Before that, he was working three jobs to make ends meet,” says Kochis. “It really took us a while to convince him that he didn’t need the second and third jobs anymore.”

On the other hand, Jeffrey Miers, a Barstow-based certified public accountant, says a young couple he knows won about $5 million in the lottery. But the husband had a substance abuse problem that was made worse by having plenty of free time and plenty of money. His friends and family have now left him, and he has nothing to show for his winnings.

Nearly everyone agrees that the most annoying problems lottery winners face stem from the publicity. The California lottery and many other contests publish winners’ names. “Suddenly, you’re going to get this money and every member of your family, as well as every guy in the world who has a business plan, is calling and faxing you within two hours of the information going public,” says Miers. “The [winner] may have made $30,000 or $40,000 a year before this in a blue-collar job, so they’re often very sympathetic to financial problems of others.”

Giving away too much isn’t uncommon--and neither is finding out that they’ve been conned, says Miers.

Milt Laird, a Sherman Oaks certified public accountant who won a walloping $27.5 million six years ago, says he dealt with the problem of constant financial requests by doing a thorough analysis of several charitable institutions and then giving his gifts to those organizations.

He suggests that prizewinners shunt all financial requests to a professional advisor, who can dispassionately look at the various “opportunities” and check out the charities, recommending which you should help and which should be rejected.

Heirs

Although there’s less fanfare, heirs’ names are also often made public through the probate process. And rich widows are considered prime targets for financial cons.

The solution, says Noelle Allen, a Cupertino, Calif.-based certified public accountant, is to not do anything until you work out a game plan.

“Before you spend Dime One, you need to think about it for a while,” Allen says.

Heirs who are unsophisticated about investing can simply put their money in bank accounts until they’ve spent whatever time is necessary to figure out how to invest it, planners say. Though the returns on certificates of deposit won’t make anyone rich, there is little risk of losing money when it is properly deposited in a federally insured institution.

But over the long term, you’ll want to get educated about investing by going to investment seminars, talking to friends and relatives and reading financial articles and books.

Those who feel incapable of handling it on their own should spend some time investigating and hiring a seasoned financial advisor to help.

Those Who Earned It

People who come into large sums of money through stock options or lump sum retirement distributions often have just one question: Is it enough to live on for the rest of my life?

The answer lies in the math. You have to determine just how much you need to live on and whether you’ll feel comfortable spending the principal. If you are young and have a long life expectancy--or heirs that you’re anxious about accommodating--you may prefer to leave the nest egg intact and live only on the investment earnings. These considerations apply if you save the nest egg slowly as well. (See accompanying chart.)

No one can know the future of interest rates or just how much inflation will reduce the value of the money, so it’s always wise to leave yourself a cushion. But if you vary maturities or diversify your holdings a bit, you can be pretty sure that if inflation and interest rates rise, you can keep up as time goes by.

But for a ballpark figure, if you think you’d be happy with $35,000 annually, you need $500,000 earning 7%--in safe CDs or Treasury bonds, most likely. If you can invest with better return, all the better, although that involves more risk.

What if you don’t mind spending all or some of the principal? The calculation becomes more complicated simply because you have to guesstimate how long you’ll live to ensure that you don’t run out of money before you run out of time. A present-value calculator, available at most office warehouse stores for about $20, will help with this.

For example’s sake, look at someone who is now age 45 and expects to live to age 95. That means he will want annual income for 50 years.

Let’s say he figures he’ll earn 7% income on his savings but that he wants $100,000 left over after the 50 years for his heirs or in case he lives longer than that. And let’s say he is happy with that same $35,000 a year.

Punch those numbers into a present-value calculator and you’ll find he needs $486,421.

That figure may seem amazingly close to the $500,000 needed to provide $35,000 in income indefinitely without touching the principal. But it illustrates the value of compounding over 50 years--the $13,600 difference in the initial nest egg makes a difference of $400,000 50 years later.

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Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or message Kathy.Kristof@latimes.com on the Internet.

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How Much Do You Need to Quit?

Whether a chunk of change falls from the sky or whether you’re gathering dollars for an early retirement, a common question is whether you can live on your nest egg-- or, more realistically, what you might need to at least start working part time. Here’s a basic guide to the income produced from variously seized nest eggs-- assuming you don’t spend the egg.

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size of nest egg needed at Annual 7% return 10% return $20,000 $285,714 $2000,000 25,000 357,143 250,000 30,000 428,571 300,000 35,000 500,000 350,000 40,000 571,429 400,000 45,000 642,857 450,000 50,000 714,286 500,000 55,000 785,714 550,000 60,000 857,142 600,000 65,000 928,571 650,000 70,000 1,000,000 700,000 75,000 1,071,429 750,000 80,000 1,142,857 800,000 85,000 1,214,286 850,000 90,000 1,285,714 900,000 95,000 1,357,143 950,000 100,00 1,428,571 1,000,000

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