People in other situations often face a similar dilemma. What if you win a large sweepstakes prize or hit the lottery? Should you take all the money in a lump sum, or take it in monthly or annual payments?
Often the temptation is to take all your money at once and invest it however you wish. However, do you know what the tax implications of that decision might be? What if you make poor investment decisions? What if you use the money to start your own business, and it fails? What if you suddenly get unexpected requests for financial aide from everyone you know? What happens then?
One the other hand, what if you take the pension or cash prize in payments for the rest of your life, and then die a year later? What would happen to your money, then?
Whether you are trying to decide how to handle a pension you earned, or a lottery you won, you need to weigh the advantages and disadvantages of whichever choice you make. The recommendations below, based on an article in the Money section of the September 2020 AARP Bulletin, may help you weigh your options.
When a Lump Sum Payout is Best
* If your private employer is financially weak and not part of the Pension Benefit Guaranty Corp., it is probably a smart idea to take the cash as a lump sum. Religious organizations are examples of employers who often are not part of the Pension Benefit Guaranty Corp. If your employer closes down over the years, or cannot afford the promised pension, they may default on their pension payments.
* If you have a history of being a successful investor, or if you have a trusted financial advisor, you may be able to handle the lump sum well on your own. However, do not let a financial advisor pressure you into taking a lump sum so he can speculate with it. If he promises that you could "make a killing," or if he "guarantees" he can make you a lot of money, you should be skeptical. No one can guarantee that your investments will always do well.
* Take the lump sum if you already know you will have a sufficient monthly retirement income from other sources, and you want to use the lump sum to pursue other goals, such as helping your children pay off student loans or putting a down payment on a house. However, do not become too generous with the money unless you are absolutely sure that your own retirement needs will be fully taken care of for 20 to 30 years.
* Take a lump sum if you are confident you can be discreet with the money and not attract the kind of attention which will cause scammers and casual friends to suddenly show up and "desperately" need your help. Are you capable of maintaining a quiet, private lifestyle and turn down frequent requests for money and gifts?
* Take a lump sum if you have reason to believe you will not live long, or if you are unable to choose a beneficiary who will receive the money should something happen to you.
When Monthly Pension Payments are Best
* According to the National Endowment for Financial Education, about 70 percent of lottery winners lose ALL their windfall within a short time, in some cases within a few weeks. If you want to make sure you will still be able to enjoy your earned pension or lottery winnings for the rest of your life, then it is a smart idea to take monthly payments. Then it will be almost impossible for you to spend all the money too quickly, leaving you penniless.
* If you are financially undisciplined, it is probably better to take monthly payments. This will prevent you from quickly giving away all the money to your friends and family, leaving yourself with nothing. It will also prevent you from splurging on expensive homes, cars, boats, jewelry and trips, spending, spending, spending until you are out of money. It takes discipline to handle a large sum of money responsibly, without quickly going through it all.
* If you are worried about how to handle the money so it will last the rest of your life, then it may be best to simply take the monthly payments. If you are anxious about how to say "no" to demanding relatives, then you will feel much less stress if you can tell them, "I'm sorry, but I only receive a small amount of money each month." They will stop thinking of you as a potential bank! Even when you choose to give them a little financial help, the amount you can offer will be substantially less.
* If you are not a sophisticated investor and could easily fall victim to smooth talking friends and acquaintances who have lots of great "investment" ideas, then you may be better off taking the money in monthly payments. Then you will always know you will have this income, without putting it at risk.
* If the payor of the monthly payments is reliable and dependable, such as the state lottery, Publisher's Clearinghouse, or an insured pension plan, then taking monthly payments could be a good choice. It is better to have a dependable monthly payment from an organization where the money is guaranteed, than hope to get a similar return from your own investments, which would not have a guaranteed return.
Whichever decision you make, it is wise to first discuss your choices with an attorney and a tax expert. They can help you determine which choice is better, and whether you should set up a family trust to accept and distribute the money, who should get the distributions if something happens to you, and what the tax implications would be. This is especially true if you are getting a particularly large sum of money.
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