Lump Sum vs. Payments Over Time
At some point during your life you may have to decide whether to receive a one-time cash payment or monthly payments over a long period of time. It could be anything from a retirement account, an injury settlement, or maybe you will win the lottery. When this situation presents itself, do you know which option is best for you? Unfortunately, it is not as simple as adding up the total monthly payments to see if they are more than the lump sum payment. The combined payments should be significantly more than the single payment as interest is being earned on the money if it is not paid out in a lump sum. The best choice for you depends on several factors.
- What interest will be earned on your money if you take a single payment and reinvest?
- What interest are you earning on the money if you receive monthly payments?
- Can you manage your money well or will you be tempted to spend it, if you have it all at once?
- Is the money critical to everyday bills, college, retirement, or is it just extra income?
- Are the monthly payments guaranteed in the event of your death?
The first two questions should be considered together. If you are able to earn more interest investing the money than you are earning by receiving monthly payments, then you should take a lump sum. Evaluate your investment options: Treasury bills and certificates of deposit (CDs) earn fixed income at a lower interest rate while bonds and stocks can give you a higher return with more risk of losing principal and interest.
Another very important factor is your money management abilities and spending habits. If you are not confident in your money management skills you will want to hire a financial planner or professional to help with your lump sum payment. The other option would be to take the payments over time. That way you can spend money as you receive it. Keep in mind, this doesn't mean to go out and rack up credit card bills because you know more payments are coming in. In fact, if you have a hard time managing your money, I would suggest keeping one credit card for emergencies and getting rid of the rest.
If the money is critical to everyday life, you may want to take the money now to help your situation. However, if a steady income is more valuable to you, then the payment stream may be a better option. On the other hand, if you plan on using the money for a time in the future, you are probably better off taking the one-time payment and reinvesting the money yourself. As a general rule, you can usually earn more interest by taking the money up front rather than over time.
Finally, you need to know how the payment stream is structured. What happens to the payments if you pass away? Do they continue to a beneficiary or do they stop? The payment guarantees vary greatly so make sure you know the specific terms of any payment stream before you accept one. I hopes this helps make your cash payment option decision an easier one.