If you won the lottery tonight and were awarded a jackpot of $1 million, you’d have a very important decision before you. No, I’m not referring to how you’d spend the money; before you get to that, you’d first need to decide how you’d want to receive your winnings – as a lump sum payment or a structured settlement.
‘Structured settlement’ is a bit of an odd term for an extremely common product. While many of us might not be familiar with the term, chances are good that we understand the principle behind it. A structured settlement is really just a stream of payments made over time. An annuity is a very common form of structured settlement. So too are pension plans. Even social security payments are a form of structured settlement; and a good one at that since they are based on unisex rates and are adjusted for inflation – two qualities not necessarily true of all annuities.
Structured Settlement vs. Lump Sum Payment – A Difficult Choice
When you are presented with the opportunity to choose between receiving an amount of money as a lump sum or a structured settlement, many factors must be taken into consideration. My aim here is not to help you make the decision between these two options for your specific situation but rather just to talk about some of the disadvantages of structured settlements and advantages of lump sum payments. Surely, there are advantages to structured settlements and disadvantages to lump sum payments and ultimately, if you are trying to decide between the two, the advice of a professional, trustworthy financial advisor could be of great benefit to you.
An Important Principal – The Time Value of Money
The biggest advantage of a lump sum payment is that you get all of your money now. If you are wise with how you spend and save it, you can invest your money and grow it at a rate that exceeds inflation, thus winding up with more money than you’d receive from a structured settlement that’s not adjusted for inflation. The time value of money is basically just the idea that it’s better to have money now than at some point in the future. If you received $1,000 today and started investing it so that it earns interest now, it will begin increasing in value. Five years from now, it’s likely that if you’ve invested it wisely, that $1,000 will be worth much more than $1,000. If however, I split that $1,000 into ten, yearly payments of $100, my $1,000 has less time to grow and over time, will probably yield me less money overall than taking the lump sum would.
While structured settlements have their place, if given the option, I will take a lump sum payment any day over a stream of payments spread out over time. Another advantage to having a lump sum payment is the ability to instantly create an emergency fund with it. In the absence of receiving a lump sum of money, it generally takes a long time to establish an emergency fund; if you receive a lump sum of cash, you can set aside enough to create a healthy emergency fund if you don’t already have one, and can invest the rest, making yourself more money in the long run.
What Would You Do With a Lump Sum Payout?
If someone gave you $1,000, what would you do with it? Would you invest it? Save it? Use it to create a start to an emergency fund? Or, would you buy something fun? Well, here’s your chance to turn fiction into reality!
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Photo courtesy: Billy Alexander