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Alan Haft

Did your client just win the Mega Millions lottery jackpot?

Tips on what to do with the lump sum bounty.

April 16, 2012
by Alan Haft

During the recent mega millions lottery hype, I heard a number of statistics on the odds of winning. Some of my favorites include:

  • I have a better chance of defeating Obama in the November election,
  • I have a better chance of being eaten by a shark and struck by lightning at the same time,
  • Winning an Oscar for Best Actor next year, or
  • Winning Olympic gold for the breast stroke in 2016

With those statistics in mind, there’s little hope I’ll wake up on any given day being able to purchase a few Bugattis or the Eiffel Tower. But you never know. There is a chance, I, like many of your clients, will one day come into a lump sum of money.

Whether it’s an inheritance, cashing out of a business, or any other significant monetary event, should your client actually wake up with a windfall of money, after the taxes are paid, costly debts are settled, and a couple of personal luxuries are understandably satisfied, the next question often becomes, “what do I do with the rest of it?”

The Rule of 120

In terms of investing the money, you might have heard of something called “The Rule of 100.” But because people are living longer, the timeless, prudent rule has for many planners been updated to “the Rule of 120.”

Rule of 120 simply helps provide a guideline to the percentages that should be invested in stocks (for growth) and in vehicles such as bonds (for increased safety and preservation). To figure it out, subtract your age from 120. The result is the percentage of stocks.

For example, suppose I receive an after-tax lump sum of $100,000. I subtract my age from 120 (120 - 45 = 75.) Therefore, 75 percent (or $75,000) of my portfolio should typically be invested in stocks for growth. The remaining 25 percent (or $250,000) should typically be invested in bonds for greater safety and preservation.

But the rule can’t end there because there are far more considerations to take into account, depending on your client’s situation. Due to space restraints, this article focuses on one option, which is how a retiree can handle a windfall.

The Retiree

Retirees often think of generating income from their investments. One somewhat out-of-the-mainstream solution your client can consider is funding an immediate annuity. In an immediate annuity, your client will basically be funding his or her pension so that it can be structured for the rest of the purchaser’s life or, if married, in a way that includes the spouse’s life as well with virtually no risk. It also helps free up money in ways not typically possible when dealing with an annuity.

In the more traditional approach of investing into stocks and bonds, “the withdrawal rate” teaches us that regardless of market earnings, typically no more than 3 percent to 4 percent of the invested asset base should be withdrawn for income use. Often, including in an immediate annuity, the overall mix increases the net amount of income that the retiree can expect to receive and also reduces the percentage of other investments exposed to market risk.

A few notable problems exist with an immediate annuity:

  • The lump sum amount contributed is often irrevocable and the only access one has to a contribution is the income stream itself. It’s for this reason that along with medical, inflationary and other important considerations that there has to be significant liquidity outside the contribution into the annuity.
  • Once your client passes away (and/or the spouse, depending on how the annuity was structured), the income stream is often gone forever, and some retirees won’t want to disinherit an heir such as children from the amount contributed.

To solve this problem, some people use dividends, interest earnings, or other portions of their money to fund a life insurance policy to replace some portion of the annuity contribution. This will reduce the net amount of income for the retiree, but the peace of mind that income for life provides, is something that can often not be replaced.

I have seen and done many income analyses for retirees. Depending on the available lump sum, it makes great sense to include an immediate annuity alongside a traditional asset base of stocks and bonds.

Editor’s Note: Due to space restraints, the author has only covered a retiree’s option. If you’re interested in learning how married couples and baby boomers should handle a lump sum of money or an annuitized payout, let me know and we’ll have it covered in an upcoming article.

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Alan Haft is an investment advisor representative with an insurance license, author of three books including the national bestseller, You Can Never Be Too Rich, and makes frequent appearances in national print, television and radio media such as The Wall Street Journal, Money Magazine, CNBC, BusinessWeek and many others. The amounts represented in this article should all be considered hypothetical and for example only.

Disclosure: This article is not intended to provide tax or legal advice and should not be relied upon as such. Any specific tax or legal questions concerning the matters described in this article should be discussed with your tax or legal advisor.

For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage services as well as commissions when implementing insurance based plans. Haft does not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views and vendor recommendations as expressed in this article are solely the author’s and do not necessarily reflect the views of the AICPA CPA Insider™ or the AICPA.