In general, people don’t do well with amounts of money significantly larger than they are used to handling. The most obvious example of that is people who win lotteries. The money typically gets wasted — bad purchases, bad investments.
Thus I would encourage you to be very careful with any large distributions of money that you might receive. Examples include:
- Life insurance settlements
- Disability insurance settlements
- Structured settlements arising from winning a court case over a tort against you.
- Pension lump sums
- Big paydays, if you are one of the rare ones in a high-paying short career like entertainment or sports
There are three problems with lump sums — receiving them, investing them, and rate of their use for consumption. Let me take these topics in the order that they should occur.
Receiving a Lump Sum
Let’s start with the cases where you have a stream of payments coming where a third party comes to you and says that you can get all of the money now. I am speaking of structured settlements and inheritances where trusts have been structured to dole out the money slowly. There is one simple bit of advice here: don’t do it. Take the payments over time. None of the third parties offering to give you cash now are giving you a good deal, so avoid them.
Then there are the cases where an insurance company is making the payments from a disability claim, a structured settlement, a lottery, a pension buyout, or an annuity that someone bought for you on your life. The insurance company will be more fair than any third party, because they aren’t usually looking to make an obscene gain, just a big one, because it reduces their risk, and cleans up their balance sheet, so they can do more business. One simple bit of advice here: still don’t do it. You can do better by taking payments, and building up money for larger purchases. Be patient.
People do best when they receive money little by little. When they get money materially faster than the speed at which they have previously earned money, they tend to waste it. It is almost always better not to take a lump sum if you have the option to do otherwise.
The last set of situations is when the party that owes the set of payments offers you a lump sum. It could be a life insurance company, a defined-benefit pension plan, a lottery, or some option uncommonly granted by another payor. I would still tell you not to do it, but the issue of getting cheated is reduced here for a variety of reasons.
The defined benefit plan has rates set by law at which it can cash you out, so they can’t hurt you badly. That said, you will likely not earn enough off of your investments with safety to equal the stream you are giving up. The lottery is often similarly constrained, but do your homework, and see what you are giving up.
One place to take the lump sum is with life insurance companies off of a death benefit. The rates at which they offer to pay an annuity to you are frequently not competitive, so take the lump sum and invest it wisely.