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How not to be blown away by a windfall

Barb and Douglas Fink of Edmonton won $1.8 million in an April lottery, after winning $100,000 in 2010 and Douglas shared $128,000 with four friends in 1989.

Barb and Douglas Fink of Edmonton won $1.8 million in an April lottery, after winning $100,000 in 2010 and Douglas shared $128,000 with four friends in 1989. Besides winning lotteries, many Canadians in an aging population are suddenly receiving huge amounts of money from a large inheritance, or the lucrative sale of real estate or a business. Just counting inheritances, estate freezes and gifts, some $1 trillion is expected to pass between generations within the next decade, according to Vancouver investment portfolio manager Adrian Mastracci.

The Investment Planning Counsel worries whether Canadians with sudden riches will be able to manage the money, deal with changes in their lives, understand and prepare for tax consequences, and invest to preserve capital while also ensuring long-term growth.

Studies show most people are ill-prepared to deal with a sudden windfall, both financially and emotionally, given how it changes their lives. H. Roy Kaplan, a sociologist at the University of South Florida, says introverted people become more anxious and suspicious after winning a lottery. He found Americans tend to move to a house in rich neighbourhoods, while Canadians tend to renovate. In the early days of lotteries some 80 per cent of winners in both countries quit their jobs, but now people who are younger, have smaller winnings and have higher education tend to keep working. It is estimated that two-thirds of lottery winners spend the money in seven years.

So how should one handle new-found riches? If you win a lottery, the personal finance blog Money Crashers suggests you make copies of the ticket and put it in a bank safety deposit box or home safe, you don't quit your job just yet, hire professionals like a financial attorney, financial advisor and chartered accountant, then change your address and go unlisted.

As for inheritances, Mastracci says they consist mostly of family homes, cottages, land, income properties, stocks, bonds, mutual funds, family businesses, plus cash and term deposits. Gifts are usually cash and savings. An estate freeze often involves private companies, family businesses, farms, income real estate and family trusts. He suggests you take your time and initially preserve capital, don't make any moves that can't be reversed, and park any cash in a savings account for at least three months. Consult other beneficiaries, plan for retirement and how to generate an income stream, seek professional counsel especially if a business is involved, and don't co-mingle new assets with your spouse or in joint accounts. When you're ready to deploy the new assets, repay credit card debt charging 19.99 per cent interest and then other loans, credit lines and mortgages. Catch up on Registered Retirement Savings Plan and Tax-Free Savings Account contribution room. Give to charitable causes. Loan money to a spouse at the prescribed interest rate, contribute to a family Registered Education Savings Plan for children or grandchildren, gift or loan money to adult children to buy houses or make RRSP and TSFA contributions, treat the family to a special vacation and do something unexpected for someone less fortunate.

In Canada, lottery winnings and inheritances are essentially tax-free, but income you earn from your new assets will be taxable. Also, be aware that a person is deemed to have sold all his or her property the moment before they died, but any increases in value after death can be taxable to the beneficiaries. People who wait years for property values to climb before selling grandma's house after she dies can face significant taxes. Also, beneficiaries are liable for any taxes on increases in value of an estate freeze as of the date it's made, which is usually many years before the person who created it dies. Even small windfalls like an income tax refund shouldn't be blown at the race track the day after it's received, it usually makes more sense to pay down debt or make RRSP or TFSA contributions.

As for winning the lottery, the British tabloids dubbed Michael Carroll “The Lotto Lout” after the garbage man won $15.5 million in 2002, only to be working in a cookie factory and almost broke in 2006.

Ray Turchansky is a tax and personal finance consultant.