Making Lump Sum Payments Work for You
Whether it's an inheritance, retirement plan payout, insurance settlement or tax refund, many Americans will receive a large amount of cash in a lump sum at some point in their life. This may make you jump for joy, but it should also prompt you to think about how you can make the money best work for you.If you've received a sizable sum and are considering what to do with it, here are a few suggestions:
Take time to weigh your options. Receiving a large amount of money is exciting and may tempt you to make an impulsive decision about spending it. It's probably wiser, however, to think carefully about how the money will affect your overall finances and how you can best use it to help reach your short- or long-term financial goals. While you're considering your options, you may want to put your cash in a low-risk, liquid investment. The money will earn a return and be readily available when you've decided what to do with it.
Review your financial goals. It may be tempting to spend your new cash on a vacation, a new car, a boat or some other major purchase. That's OK if you spend the money on one of your top priorities. But before you spend the money, review your family's short- and long-term financial goals and consider how the money could help reach them.
Perhaps investing the money now will help pay for your child's college costs in ten years, or maybe you're approaching retirement and increasing your savings will put your nest egg on the fast track. If you've been trying to save several months' income in cash reserves for emergencies, your lump sum may make that task easier. Whatever your goals, prioritizing them will help you decide what to do.
Pay off debt. One of the most effective ways to spend a lump sum may be to pay off high-interest debt. Such debt may include balances on credit cards and non-deductible loans for cars or other purposes. Categorize your debt according to the interest rate and pay off the debt with the highest interest rate first. After taking care of your high-interest debt, you may want to make extra payments on your mortgage or home equity loan.
Put your cash to work. Investing your cash instead of spending it may help you increase the size of your lump sum over time. One smart way to invest for long-term goals is to maximize contributions to your IRA, if you're eligible. If you meet income eligibility requirements or do not participate in an employer's plan, a traditional IRA gives you a current-year income tax deduction and tax deferral on earnings, while a Roth IRA offers tax-free distributions later instead of an up-front deduction. Whatever your retirement goals, consider consulting with a financial advisor for help in creating an investment plan and choosing securities that are suited for your investing time frame and risk tolerance.
Consider taxes. The tax consequences of your decision are important reasons to review your plans with a knowledgeable financial advisor because a large lump sum could easily change your income or estate tax situation. If your payout is from a retirement plan, for example, you may have a limited time to roll the sum into another retirement account to avoid a tax bill.
Enjoy your good fortune. Planning and investing for your future goals is important. But there's nothing wrong with using some of your cash to buy something you might not otherwise have been able to afford (or for which you would have had to take a loan). You also may want to share your good fortune through gifts to relatives, friends or favorite charities.
Regardless of how you spend your lump sum, consider your options carefully and develop a goal-oriented investment plan to help you get the most and longest lasting financial benefit from your new-found wealth.
--Judy A. Rubino, CFP is a certified financial planner in the downtown Portland office of American Express Financial Advisors. The registered office address is 1800 SW First Avenue, Suite One, Portland, OR 97201. The office phone number is 503-525-2898.
