I’m often asked how to invest a lump sum of new cash. The answer depends on several factors: where the money came from, the amount relative to your current savings and how it was invested before you received it.
Lump sums can come from several different sources — a pension payout through a job change or retirement, divorce, inheritance, the sale of property or a business, or perhaps winning the lottery. For the purposes of this blog post I’ll assume you’re receiving a cash payout rather than an in-kind inheritance of stock or property.
Here are 4 simple rules to help decide on the direction you should take with a Lump Sum.
1. What is the size of the lump sum relative to your existing savings? If it is small, regardless of where it came from, invest it all at once and be done with it.
2. Was this money from an employer pension plan? If the answer is yes, then the cash was recently in a tax-deferred account and will suffer tax consequences if not rolled over to another tax-deferred account within 90 days.
3. Was the money from the sale of a business or property? If the answer is yes, then there was a previous business risk attached to that money even though it wasn’t equity risk. In this case, consider investing half of the money in the markets today and Dollar Cost Average the remaining half over the next 2 years. This spreads out the entry-point risk into the markets.
4. Was the money inherited, won, or from another source where you had no previous ownership?
This information I shared provides some good points for the direction of lump sum investing, but it doesn’t discuss where to invest it.
That depends on your financial situation — although receiving a lump sum often changes that. Here are a couple of rules to help with investment decisions:
1. If the lump sum is 50 percent or less of your current savings as described in #1, then your asset allocation shouldn’t be affected. Simply invest according to your current investment policy.
2. If the lump sum is more than 50 percent of your current savings, then you should consider reviewing and revising your overall investment strategy. You can do this on your own by reading investment books, or you can get help from a low-cost investment advisor, or a well educated Financial Professional.
SOME PRODUCTS to consider for Lump Sum Investing…
Certificate of Deposits
CDs are similar to savings accounts in that they are insured "money in the bank”. In the USA, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA) for credit unions. They differ from savings accounts in that the CD has a specific, fixed term (often one, three, or six months, or one to five years) and, usually, a fixed interest rate. The bank intends that the customer holds the CD until maturity, at which time they can withdraw the money and accrued interest.
Bank CD Illustration:
Invest $10,000 @ 4% you’ll earn $400.00 the interest you earned is NOT tax deferred so you will pay taxes on that amount you made… If you are in a 35% tax bracket take $400.00 times 35% and you will pay Uncle Sam $140.00 of your $400.00 netting you $260.00 (2.6%) So your balance in actuality is$10,260.00
And let’s say that inflation is at 3% for the year meaning what $10,000 dollars a year ago could buy will now cost you $10,300.
So, in reality, you have earned a loss of $40.00….$10,300.00 minus $10,260.00.
Mutual Funds
A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. ALWAYS ask for the mutual fund's prospectus and READ IT! It will show you exactly how much and where the money in the mutual fund is diversified.
One of the main advantages of mutual funds is they give small investors access to professionally managed, diversified portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gain or loss of the fund.
Mutual funds invest in a wide amount of securities, and performance is usually tracked as the change in the total market cap of the fund, derived from aggregating performance of the underlying investments.
Mutual fund units, or shares, can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS. A fund's NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding.
Fixed Annuities
A fixed annuity is a type of annuity contract that allows for the accumulation of capital on a tax-deferred basis. In exchange for a lump sum, a life insurance company credits the annuity account with a guaranteed fixed rate of interest while guaranteeing the principal investment. A fixed annuity can be annuitized to provide the annuitant with a guaranteed income payout for a specified term or for life.
Fixed annuities are contracts issued by life insurance companies to individuals looking for guaranteed rates of return without any risk to principal. Because they are a type of insurance contract issued by a life insurance company, they enjoy some of the same tax benefits of life insurance policies, such as the tax-deferred growth of earnings.
Taxes are eventually paid when the earnings are withdrawn or when the contract is annuitized for monthly payments.
The rates on fixed annuities are derived from the yield a life insurance company generates from its investment portfolio, which is invested primarily in high-quality corporate and government bonds. The yield on fixed annuities is typically higher than the yield on equivalent, riskless investments and is often guaranteed for a period of one to 10 years.
Variable Annuities
A variable annuity is a tax-deferred retirement vehicle that allows you to choose from a selection of investments, and then pays you a level of income in retirement that is determined by the performance of the investment options you chose. The value of your investment fluctuates. The investment options for a variable annuity are typically mutual funds that invest in stocks, bonds, money market instruments, or some combination of the three. To summarize, investors pay a premium to the insurance company, which then buys accumulation units under the investor's name.
Fixed Indexed Annuities
With an index annuity, the annual growth is benchmarked to a stock market index (e.g., Nasdaq, NYSE, S&P500, CROCI) rather than an interest rate.
An index annuity’s growth is subject to rate floors and caps, meaning it will not exceed or fall below the specified return levels even if the underlying stock indices fluctuate outside of those set parameters.
In simplest terms, the insurance company bears the risk of a sharp stock market decline with this type of annuity. You cannot lose any of your principal with a fixed index annuity, and your potential gains are usually capped at a rate between 3% and 9%.
With a LUMP SUM, I feel your Retirement needs, should to be an important focal point.
Retirement, as we know it, is changing. Years ago, retirees could rely on their government programs, pensions, and personal savings.
Today, due to the impact of inflation, volatility, taxation, and health care costs, those programs no longer make up a significant portion of their income for retirement.
Most retirees now have to rely mostly on their personal savings and other creative ways to fulfill their retirement income need.
That is why many Americans consider purchasing an annuity to help achieve their needed income in retirement. People can buy an annuity for its qualified plans, legacy strategies, long-term accumulation, growth options, tax advantages, and, most importantly, for the retirement income it provides.
When considering an annuity, it is helpful to ask yourself the following questions to determine if this option fits your retirement needs.
- Am I concerned about finding a secure retirement plan to help protect my savings?
- Would knowing that I have a guaranteed income stream that I can depend on every month be of importance?
- Do I want all of the potentials of upmarket swings with absolutely no chance of losing any money with downside loss potential?
If you answered “yes” to any of these questions, an annuity may work well for you to fill any income gap you may face in retirement.
It's crucial for you to understand the importance of creating a stream of lifetime income for your retirement. You can manage your lifestyle, avoid market volatility and potentially create a lifetime income simply by having a conversation with a Financial Professional about how you can create a retirement income plan with annuities.
I feel two of the most important factors you must know and consider when receiving a LUMP SUM is investing Tax Deferred or Non Tax Deferred?
When you invest Tax Deferred you are exponentially growing your investment, because you do not have to pay taxes on your interest earned every year.
For instance, an illustration with real numbers would look like this……
Consider a $2,000 investment in a fund that has a 12% rate of return, compounded annually.
Non-Deferred in a 35% tax bracket this $2,000 would equate to $1,300.00 net investment with a 7 ½ % yield
Over a 20 year period this would grow to $56,296.00
That same $2,000 investment in a fund that has a 12% rate of return, compounded annually Tax Deferred stays $2,000.00 and would accumulate without paying annual taxes and at the end of 20 years the balance would be $144,104.00
BIG DIFFERENCE $87,808.00!!!
In summary, I highly recommend considering an Annuity, with an annuity it is similar to a savings account with an insurance company or other investment company. A person can make either a lump-sum deposit or periodic payments to the company and at retirement, he or she receives regular payments for a specified time period.
All the payments build up tax-deferred and are taxed only when withdrawn at retirement. Annuities come in a variety. As I shared, Fixed, Fixed Indexed, or Variable.
In a fixed annuity the insurance company guarantees your principal plus a minimum rate of interest, you get the low-risk appeal of a guaranteed minimum return (usually 2% to 3%).
A variable annuity does not provide the same guarantee and the investment value fluctuates with the performance of the investment.
A Fixed Indexed Annuity gives you the best of both worlds. Indexed annuities are a combination of a fixed guaranteed return and a variable annuity.
You participate in the growth of whatever Index you decide and it either has a participation rate or a Cap. You get all the benefits of any upside gain without any risk of ever losing any money because you cannot and will not participate in a loss.
Your gains are locked in every anniversary period.
Receiving a lump sum doesn’t need to be daunting. The investment timing choices are fairly straightforward. The points I have shared should help determine a satisfactory solution and provide you with the peace of mind you’re looking for.
It would be an honor and privilege to help you with any and all of your financial needs.