There are several things that need to be considered when assessing whether a payment should be made all at once, or in smaller increments. As a financial planner, the most important thing I consider is the time value of money (TVM). The time value of money is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.
However, there are a number of other factors to consider when weighing these options aside from the TVM.
Advantages of Paying a Lump Sum
If you’re looking for closure and just wanting to move on, this may be an appealing option. Just don’t be too hasty in your decision making, and weigh all of your options first. A lump sum should take into consideration a reduction for the TVM, and if the interest rate of return is acceptable to you considering you are parting with all your cash up front.
When a long payout period for child or spousal support is being considered, there is sometimes a requirement have insurance in place in the event that the payor becomes disabled, critically ill or dies prior to meeting his/her financial obligation. A lump-sum payout would save the cost of having to put this insurance coverage in place.
Disadvantages of Paying a Lump Sum
The payor may not be in a position to make a lump-sum payment to his or her ex-spouse. It may be appealing to be over and done with, but not at the sacrifice of leaving yourself cash-strapped.
Another thing to consider is the spousal support income tax deduction. Since spousal support is eligible to be deducted by the payor, paying in a lump sum will not give the sustained income tax relief that a recurring spousal support payment would allow. If someone wanted to pay a lump-sum amount and opted to finance the payout, the interest charges (if applicable) are not tax deductible.
Spousal support can continue until the ex-spouse remarries or dies, so a lump-sum payout wouldn’t necessarily be advantageous should either event occur prematurely.
If you know that money management is not a strong suit of your ex-spouse’s, you may want to help manage the risk by paying monthly amounts, especially if there are children involved. By ensuring that monthly amounts are sent to your ex-spouse, it helps prevent the potential of overspending, and contributes to proper monthly budgeting.
Advantages of Receiving a Lump Sum
If your ex-spouse is unreliable, a lump-sum amount minimizes the likeliness of you having to chase down monthly amounts in the case of non-payment, and potentially reduces negative effects on your monthly cash flow or credit rating. The payee also won’t have to worry about payments should something happen to the payor’s income due to job loss, sickness, disability or death.
If you’re a shrewd investor or want to get back into the housing market again, a lump-sum amount will afford you the opportunity to reinvest the money or put it toward the purchase of a home or other significant purchases.
Disadvantages of Receiving a Lump Sum
Having access to a large sum payout for spousal support could be dangerous for the payee. Putting a firm budget in place or reinvesting the lump-sum amount in an annuity will help prevent overspending.
It’s important to know your strengths and your weaknesses when it comes to personal financial planning. Set yourself up to win. If you’re not great at budgeting, taking a monthly amount versus a lump sum may be the best option. If you’re wise with money, rely upon the trusted counsel of a financial planner, and adhere to a strict monthly budget, a lump sum may be a better option for you.
Obviously, there are pros and cons to each scenario. By determining what will be best for your own needs, and the needs of your children, hopefully you can arrive at solution that supports the financial and the emotional requirements of you and your ex-spouse.