Should you take a onetime lump sum payment or should you spread the payment out over the course of many years? Believe it or not, you may actually get the chance to make a choice like this. And, you need to have all the facts and understand how your choice can affect your family.
Typically, we think of this choice when a new lottery winner is announced. We all tend to daydream about what we would do with a huge lottery win, and that also includes how you would choose to accept the winning payout. Is a reduced lump sum payment better? Or, should you parcel out your winnings a little bit each year over the course of 20 or 30 years in the form of an annuity?
Now let’s flip this on its ear a little bit. Imagine the same questions with respect to a life insurance payout, your retirement nest egg, private pension plan, or an inheritance. Now, the chance of having to make this tough choice is a lot more realistic and likely than those dreaming of pocketing those lottery millions.
The Benefits Of Taking A Lump Sum Payment
A dollar today is worth more than a dollar in the future. This is true thanks to inflation. It is not that a dollar is worth more because a dollar is always worth one dollar. But, we can buy more things with money today than the same amount will buy us in the future. So, if you had the choice of a million dollars today, inflation alone would make you want to take it as a lump sum and not spread it out over years where your buying power will be reduced.
Having your entire lump sum immediately also puts the investing decisions in your own hand. When you choose to take your winnings or payout in an annuity over the course of decades, you are letting others invest your money however they want. They can reap huge benefits if their investments with your money increase on still only have to pay you the set yearly payout amount of your annuity.
The Drawbacks Of Taking A Onetime Payment
Taking the money in one lump sum payment can have some dangerous consequences. There is the potential to spend the money frivolously if you receive it all at once. And, of course, once it is gone and spent foolishly, then it is impossible to get back. Another drawback to receiving a onetime payment is that you will typically receive less money today than you would receive when you add all of the annuity payments together.
Why You May Want To Consider Monthly Payments
A lump sum payment may not be for everyone. There are several reasons why you may want to consider taking monthly annuity payments instead of a lump sum. If you don’t have discipline not to waste a large sum of money, then you may be better off having a company pay you monthly or yearly sums over the course of decades. Also, taking annuity payments instead of a single lump sum will allow you to receive a larger total over the course of the payments when added together because lump sum payments are much smaller than the amount won.
The Dangers Of Monthly Annuity Payments
It is not simple to just choose the monthly or yearly annuity payments either though. They have their own set of drawbacks as well. When you choose to take payments a little along, the money is worth less in the future when you receive it than it would be had you received it today. The bank, insurance company, lottery, and others actually keep your earnings and provide you a set return on the investment that they now own instead of you even if they earn a higher rate of return than your annuity payment. Another drawback of monthly payments are the low interest rates that we have seen for years now thanks to the Federal Reserve’s policies. Lump sum payments are worth more and larger in low interest rate environments. And, finally, what if you outlive your payment schedule? You will need to check the fine print to make sure that your heirs receive your payments should you die before the end of your collection period.
It is not as cut and dry a decision as to whether you should take a lump sum payment or monthly payments in the form of an annuity. They each have their own benefits and drawbacks like most financial decisions we all face. You have to make the choice that is right for you and your family, based on your goals, and with the understanding of all the consequences of your choice.