Financial windfalls To lump or not to lump

What would you do if you suddenly won $10 million? Would you start spending the money right away? Would you begin to put together a wish list?

If you were prudent, the first question you should ask before taking any big payout is, "Should I take it in a lump sum, or paid out over time?"

The right answer depends upon your circumstances and goals. Consider them carefully. The wrong choice can cost you.

If you can stomach some risk, a lump-sum payout could work to your benefit. Moshe Milevsky, of Toronto's York University, compared three scenarios:

A pension paid out over time;
One taken as a lump sum and invested in low-risk money market accounts; and
One taken as a lump sum invested half in stocks, half in lower-risk securities.

The results? The lump sum invested half in stocks outperformed the other options.

(Note to job changers: When you leave a job, you are often asked to choose whether you want your 401(k) money in a lump sum, or rolled into an IRA or your new employer's plan. It is often recommended you choose one of the latter two options. The taxes and penalties that come with taking out retirement assets before age 59 1/2 can cost approximately 40 percent of the money you have saved.)

Look at your total picture. If your cash flow is comfortable but you have not saved as much as you would like for retirement, taking a lump sum and investing it might be the best thing.

If your cash flow is weak but you have a cushion set aside, a cash stream might be better.

What are your goals? Consider a $1 million lottery win, paid out over time. Typically, you will receive $50,000 a year for 20 years. After federal taxes (at 28 percent), that's just $36,000 a year. It's a new car or college tuition or, if you invest wisely, retirement security.

But it's not a 10 percent down payment on a $1 million house or enough seed money to start a new practice.

If these are your goals, it is often better to opt for a lump sum. You will get the present value at current interest rates, about $548,000 in this example.

If you opt to take an annuity and then change your mind, you'll have to go to a settlement company to convert the payments, and that can be expensive.

Nothing can take the place of proper planning when it comes to making the best decision for your situation. Take the time and make the effort to evaluate all of your options. A mistake here could be very expensive when it comes to your financial goals and objectives.

Edward R. Collins, AAMS, RFC, is a family wealth-management specialist at Collins Wealth Management, LLC. He can be contacted at 973-292-8728. To learn more about his approach to wealth management, visit his Web Site at www.collinswealthmanagement.com.