Getting your hands on extra money is pretty much always a good thing. If you've won a prize or the lottery, you generally have two options for receiving that cash: You could either collect a lump sum payment, or get paid over time in regular installments. While there are benefits to getting your money up front, you may be more likely to save more of it by collecting smaller scheduled payments over time. It's important to consider the financial implications of both avenues before making a decision.
How should you get paid?
The concept of getting paid up front versus over time typically comes up when you win the lottery or a similarly structured prize. Winners are generally offered the option of a lump-sum payout where the prize is paid at once, or an annuity that pays out in increments over a period of time.
What complicates the decision is that, with a lump-sum payout, you'll typically end up getting less money in total than you would via an annuity because of taxes and other calculations that come into play. On the other hand, there's the time value of money to consider. If you're not familiar with the concept, it basically means that money you receive today is worth more than money you get in the future because of its growth potential. So if you take all of your money as a lump-sum payment and invest it wisely, you could wind up coming out ahead, even if your payout is reduced.
Just how much of a return would you need to generate to make the lump-sum payout worthwhile? You can use this handy calculator to find out:
This tool allows you to run different investment scenarios to see what type of return you'd need to make the lump-sum payment worthwhile. Of course, in the absence of a crystal ball, it's hard to predict how your money will perform if you invest it yourself, but you can, at least, compare some numbers to see whether you're better off investing a lump sum or collecting payments over time.
Other factors to consider
Of course, it's not just your potential return on investment to ponder. You should also think about the way taxes might change in the future. If rates go up, you could lose out by getting paid over time. On the flip side, if you expect rates to go down, it might pay to take the annuity.
Another significant point to consider is whether or not you can be trusted to invest that money wisely if you do opt to receive it in full. Getting paid over time is sort of like buying yourself a built-in insurance policy that you won't blow through the cash all at once. After all, you can't spend money you don't actually have yet.
It's estimated that almost 70% of lottery winners end up broke within seven years. Before you decide whether to get paid in full now or over time, think about your spending and saving habits. Does saving come naturally to you? Or do you have a tendency to bust your budget the minute you're tempted?
While taking a lump sum payment could very well work out in your favor, you stand to lose your earnings and then some if you don't treat that money responsibly. The more honest you are with yourself, the more likely you are to arrive at the best decision.