Rookie Move: Financial Mistakes to Avoid with Your First Contract

When athletes sign their first major professional contract, the thrill of a massive paycheck can often overshadow the need for prudent financial planning. Despite their exceptional on-field intelligence and discipline, many athletes find themselves grappling with the intricacies of personal finance for the first time, swiftly transforming their millions into a series of costly regrets. Consider research conducted by the Global Financial Literacy Excellence Center which found that athletes start declaring bankruptcy as early as two years after retirement while 16% of NFL players go bankrupt within 12 years of retiring.1 While a number of factors contribute, early missteps can prove particularly detrimental. Let’s delve into a typical scenario where an athlete stumbles into critical financial pitfalls, including unchecked overspending, a failure to account for taxes and recurring expenses, and improper payment structuring.

The Initial Contract: A $40M Dream Deal

Imagine a rookie signing a four-year, $40 million NFL contract. In Year 1, they receive a staggering $26 million, primarily from signing bonuses, with the remaining $14 million spread over the next three years. Flush with cash, the athlete feels an overwhelming sense of financial security. However, the looming complexities of taxes, coupled with extravagant lifestyle choices, will soon present formidable challenges. Without astute financial planning, that initial windfall can quickly erode, leaving the athlete vulnerable to the harsh realities of mismanaged wealth.

Mistake 1: Buying an Expensive Home Right Away

With $26 million on the horizon, the star athlete splurges on a $13.1 million mansion, assuming it’s well within their means. However, after accounting for federal, state, and local taxes—particularly California’s hefty 13.3% state tax and the 37% federal tax—the athlete retains only about $14 million of the original $26 million. This means nearly the entire Year 1 income is tied up in the home, leaving a mere $900,000 for living expenses, agent fees, and other costs. This seemingly reasonable purchase has drastically reduced their financial flexibility.

Mistake 2: Being Overly Generous

Superstar athletes signing their first contract often feel pressure to share their newfound wealth with friends and family who have supported them along the way. It’s natural to want to give back, but handing out too much cash can quickly drain resources, just like splurging on luxury items. Instead, consider setting up a trust to help manage these gifts responsibly.

Mistake 3: Failing to Account for Property Taxes and Recurring Costs

The cost of maintaining a luxury $13.1 million home—including recurring expenses like property taxes, insurance, and upkeep—can quickly add up. In California, the annual property tax rate is about 1.25%, resulting in $163,750 per year in property taxes alone. Insurance and maintenance add another $155,000 to $310,000, bringing total annual costs to roughly $319,000 to $474,000.

With only $900,000 left after the home purchase, our rookie can technically cover these expenses in Year 1 but faces tight margins. In subsequent years, when the after-tax income drops to around $2.5 million per year, nearly 20% of this income will go toward home-related costs, leaving little room for savings or unforeseen challenges.

Mistake 4: Getting “Too Creative”

Another mistake is attempting to be paid through an LLC in order to take advantage of business tax breaks. Importantly, as a W-2 employee of the NFL, the athlete is ineligible for this payment structure. What’s more, the improper use of an LLC can trigger IRS audits and penalties. The same could be said for the risks associated with trying to use captive insurance to avoid taxes. While some athletes consider these to insure against risks specific to their career—such as injury or loss of endorsement deals— captive insurance involves significant regulatory compliance, including regular audits and financial reporting. In the end, misguided financial advice or a poor grasp of tax laws can result in wasted time and missed opportunities for more effective financial planning.

The Long-Term Impact

The athlete’s decision to spend nearly all of their Year 1 income on a house sets them up for future financial strain. They now have minimal savings or investments and must shoulder hefty recurring expenses for the home. Ultimately, their $40M dream contract has dwindled after four years. And given that the average NFL career lasts just 3.3 years, any early injury or contract cut could leave the athlete in financial jeopardy. That is not a risk we’d be willing to take.

This scenario highlights how quickly financial mismanagement can unravel even a multi-million-dollar income. Of course, this doesn’t account for the few rookies who are fortunate enough to earn significant money off the field, but they are rare exceptions. Instead, pros should prioritize sound financial planning by:

• Engaging Financial Experts: Consult with seasoned financial advisors to adeptly navigate the complexities of taxes and spending.
• Grasping Tax Implications: Fully understand the tax impacts on income and strategize accordingly to maximize take-home pay.
• Curbing Early Overspending: Resist the temptation to splurge on large purchases early in their careers, preserving capital for future needs.
• Prioritizing Savings and Investments: Focus on building a robust portfolio of savings and investments to secure long-term financial stability.

By making disciplined financial decisions, professional athletes can avoid becoming cautionary tales for their peers and instead set themselves up for lifelong success.