Life expectancy is extremely important when determining if a lump sum makes sense for you. The reason life expectancy is so important is because the longer you live, the more monthly payments you will receive. For example, let’s say you are offered the choice of a guaranteed monthly payment of $3,000 or a one-time lump sum of $500,000. If you pass away in two years you will have received only 24 monthly payments or $72,000. Monthly payments did not work out so well. On the other hand, if you live 30 years you will have received $1,080,000—significantly more than the lump sum offered.
Risk tolerance is a person’s willingness to accept risk for the possibility of higher investment returns. A person who is risk averse is more likely to accept a lower rate of return for greater certainty of future outcomes. In other words, a risk averse person prefers safe and stable investments even if it means slow growth. A risk seeker, on the other hand, is somebody who is willing to accept uncertain returns (volatility) for the hopes of higher investment returns.
If you are in need of income right now, monthly payments may make sense for you. On the other hand, if you are not in need of income for several years, the lump sum may make sense for you. A big reason for this is the more time you have to let your money grow before you need to access it, the more risk you can take. As we discussed above, higher risk equals potentially higher returns.
It is very important to take the time to educate yourself on whether or not a lump sum payout is right for you, and you have already taken a big step toward making an informed decision.