BlueSky Wealth Advisor Stephen Fletcher, CFP®, MBA explores the causes and remedies for the money problems frequently faced by the suddenly wealthy:
Getting a sudden windfall seems like a dream come true. Who wouldn’t love to be “given” a significant amount of money? You could buy that new car, house on the beach, or maybe be able to fully provide for your friends and family. While it seems like a lucky break, the reality is that the majority of people who receive a sudden windfall end up in difficult financial straits or bankruptcy. The most common example of this “riches to rags” scenario comes from the world of professional athletics. Perhaps this is because these men and women are in the public eye and their financial condition is the most reported. Becoming a professional athlete is a type of jackpot; throughout their pursuit of reaching the top league, athletes receive no compensation apart from scholarship monies provided by their schools. Once they make it big, large paychecks immediately begin to flow in, making it all too easy to be lured into a fake sense of wealth.
How bad can it be?
Sports Illustrated conducted an anonymous survey of retired NFL and NBA players. The results of their survey were shocking: after only 2 years of retirement, 78% of NFL players were either bankrupt or under severe financial strain. NBA players weren’t much better, with 60% bankrupt within 5 years of retirement. Despite average career earnings of $6.65 million for NFL players and $24.72 million for NBA players, the money is still drying up. Despite what you may think, it’s not just the players who aren’t superstars that are running out of money. Mike Tyson, Allen Iverson, and Terrell Owens are all broke.
What goes wrong?
For those who suddenly receive a lot of money, or are getting a large paycheck, there are several issues that can contribute to financial ruin:
- Financial predators. Professional athletes, lottery winners, doctors, and entrepreneurs are specifically targeted by the best salespeople. Generally, those who can earn a large commission by bringing in new business target those who make a lot but are too busy focusing on their profession to be able to take the time to understand what the “advisor” is selling or proposing, mostly because the sales person is intentionally talking over their heads. Darren McFadden, a running back for the Dallas Cowboys, recently sued his former financial advisor, alleging manipulation. His advisor made McFadden sign a Power of Attorney, signing all financial authority over to the advisor. What was sold to McFadden as an opportunity to make things easier, smoother, and cheaper ended up costing him a significant sum because he wasn’t working with the right people.
- Lack of financial discipline. Without sitting down with a planner or financial advocate, lifestyles can easily begin to run away from those earning a lot right out of the gate; student loans and mortgages aren’t at the forefront of their mind, but a good lifestyle is. Without taking some time to see where the money is going, and putting together even a rudimentary budget, dollars fly out the window on things that are very much ill-advised purchases.
- Paying their “fair share.” Perhaps the largest cause of financial strain on high earners, and the one least thought of, is taxes: large incomes produce large income tax liabilities. Homes come with mortgages and real estate taxes. Cars come with property taxes. Lavish gifts to friends and family could eventually come with gift taxes, at the usurious rate of 40%. With no advisor other than a CPA, who in most cases is merely preparing the returns, a plethora of opportunities to reduce taxable income go unused. Once retirement begins for athletes, or as retirement looms for doctors and businesspeople, the large outflows for these taxes begin to take an even larger toll. Retirement savings haven’t been as large as they could have been, and unless tax planning is done carefully, large tax liabilities can haunts retirees who have left the accumulation stage of their lives and moved into distribution.
What’s the solution?
Enter your financial life the same way you would your professional life—with a game plan.
- Answer the important questions. Life can have many unforeseen events that could disrupt your earning potential. That’s why it’s important to have, at the very least, a rough understanding of what you want to accomplish outside of your professional life. There are important questions you can ask yourself right now. How much do you want to make? For how long? When do you want to retire? What are your savings goals? What is your spending rate? It is important to have these questions answered in order to form a successful financial gameplan. Without the ability to maintain some form of discipline with your wealth, chances are you will be living paycheck to paycheck while spending your hard earned money on fleeting extravagance.
- Put together a budget. Even those with a lot of money need a budget. Debt can be a very effective tool for sophisticated consumers, as long as there is a plan to get out from under their debt. There’s nothing wrong with a lavish lifestyle, but there should be limits; if your lifestyle exceeds your income, it doesn’t matter how much you earn, you’re heading in the wrong direction.
- Partner with the right person. Find an advisor who can help you work through all of the financial hoops in your life, with an understanding of the impact that taxes, insufficient insurance, and poor investment allocations can have on your financial plan. There are too many stories to recount about professionals who, because they came into large paychecks quickly, were targeted by unethical advisors and after they had been cheated, sued their advisor after the damage had already been done. Darren McFadden, Tim Duncan, Dwight Freeney, Terrell Owens, Jorge Posada, Vince Young and Mike Tyson have all had to seek recourse from an advisor who didn’t place their client’s needs first. When looking for the right advisor, it’s helpful to know the right keywords. A “fiduciary” is someone legally obligated to place your needs and interests above their own. That’s always a good place to start when looking for a partner you can trust. It is also imperative that you understand your advisor’s fee structure; are they only paid by you, and if so, how? From some hidden fee, or an upfront cost? Can they receive kickbacks from other advisors by investing your assets in specific funds, or by selling you a specific insurance policy? If they can’t clearly and concisely outline how they receive their fee, don’t sign up.
Most of us don’t end up winning the lottery. The large incomes received are incomes that are hard earned. Make sure you take all of the steps necessary to not just enjoy those first few years of making your hard earned money but make your money work hard for you to ensure your financial future is secure. Go into your professional life with your eyes wide open and with a game plan. Make sure you stick to your budget and build up your team with people who will work hard to make sure you succeed. By doing these things, you can “hit the jackpot,” but avoid the kiss of bankruptcy.
Already a professional without a financial gameplan? It isn’t too late to make one. Contact us at BlueSky to learn how we can get you back on the winning side of wealth.