TheTimesTribune.com, Corbin, KY

January 8, 2013

Take money in annuity instead of lump sum


The Times-Tribune

CORBIN — “Now, baby we can do it. Take the time, do it right. We can do it, baby. Do it tonight.” -The S.O.S. Band

Taking money over time is a tenet of my faith. I believe in God, the Cincinnati Reds and not taking money in a lump sum.

I’ve spent more than 30 years in the structured settlement business, encouraging people to take payments over time. Watching thousands of people blow through lump sum payments made me a true believer in the power of lifetime income.

As I note in my new bestseller, “Life Lessons from the Lottery:  Protecting Your Money in a Scary World,” 98 percent of lottery winners ignore my advice. Thus it is no surprise that most of them blow the money in five years or less.   

The same statistics hold true for people getting money from an injury settlement, inheritance or retirement. It doesn’t make a difference if it is a $10,000 lump sum or a $10 million lump sum. People blow through the money.  

It makes sense when you think about it. People are used to having money come in every month.   Mortgages, utilities and almost every kind of bill payment are done monthly. People get paychecks on a bi-weekly or monthly basis. They get social security and defined benefit pension payments on a monthly basis.  

Thus, managing a lump sum is a completely foreign skill. As survey after survey shows, most people don’t do well.  

Taking lottery payments over time allows you to adjust with the money coming in on a gradual basis. If you make mistakes and lose all your money the first few years, you have 24 more opportunities to get it right.

I’ve watched several lottery winners become miniature versions of Powerball winner Jack Whittaker and do silly things the first year or so. If they have a couple of years to adjust, they eventually settle down and enjoy the money.  

There are also some tax advantages to taking lottery money over time, as you are taxed on the money as you receive it. That may not be relevant with $100 million, as you are always going to be in the highest tax bracket, but a person who gets $1 million and takes $50,000 a year should be able to save.  

When I worked as a Series 7 registered representative (often referred to as a “stockbroker”), I had a large clientele of doctors, lawyers and other well-educated professionals, along with injured people and the occasional lottery winner.  I had my clients allocate their money into several types of investments and did my best to keep them from panicking when one class of investments did poorly.  

Over the years, I kept noticing one thing: People who had easy access to cash were the ones most likely to fall off the bandwagon. They would have “emergencies,” such as wanting to buy a new car, a houseboat or taking their friends on a cruise. Sooner or later, the money would be gone.  

In the meantime, I had a parallel business that provided structured settlement annuities to injured people. Structured settlements are only offered to injury victims and are tax-free. Thus, they are an attractive choice compared to taxable alternatives.  

A structured settlement annuity can be designed in a number of different ways, but the way I normally recommend is to pay it out over a person’s lifetime, increasing at two or three percent a year to keep up with inflation and guaranteed for 30 years to a beneficiary in case the person dies.  

One of my first clients was a young man who lost his arms and legs in an accident and lived with a motorcycle gang. He received roughly $3 million. If he and the motorcycle gang had gotten their hands on $3 million, they would have had the party to end all parties until the money was gone.  

I set him up so that he received $10,000 a month.  Thus, they had a party every month up until he died many years later.  You can’t really “cash in” a structured settlement, although some people make the unfortunate decision to sell their payments to companies that heavily advertise daytime television shows such as Jerry Springer.  

Because the money was harder to access, the people who took structured settlements were more likely to have a stable and happy life than clients who could cash in a mutual fund or stock whenever they wanted.  

I realized the psychology was like dieting. I struggle with my weight and used to start a diet about once a month. If I start, but have all my favorite foods in the refrigerator, I will fall off the diet immediately. If I have to drive to the store about two miles away, I think about it more and sometimes won’t go. If I have to drive 25 miles to get fatty foods, I am far more likely to stick to the diet.

The financial analogy is that having all your money in a savings or checking account is like having food in the refrigerator. Putting money in a mutual fund or certificate of deposit, where it takes some effort (and sometimes penalties and tax consequences) to cash it in, is similar to driving to the store two miles away. A structured settlement is like the 25-mile drive for food. You have to do a lot of work to sell it and take a huge financial hit when you do.  It is better just to hang onto the structured settlement and stay disciplined, just like it is better to stay on a diet.  

Eventually, I moved away from a successful career as a stockbroker and focused all my efforts on the structured settlement business.  

Although many of my eggs are in the structured settlement basket, it was closer to the Will Rogers’ philosophy of being concerned about return of my money as opposed to return on my money.  

There is something similar to a structured settlement called an immediate annuity. It pays income for a person’s life, just like a defined benefit pension plan. Although people seem to like lifetime income from a retirement plan, a Smart Money article stated what I long suspected: Few people buy them on their own.  

I never understood why until I read an article called “The Annuity Puzzle” in a June 2011 edition of the New York Times.  

Dr. Richard Thaler, a professor of economics and behavioral science at the University of Chicago, discussed how purchasing an immediate annuity with 401k retirement money, with fixed and guaranteed benefits, was a simple and less risky option than self-managing a portfolio or having the people on Wall Street do it for you.  

He also noted that not enough people buy annuities. Thaler suggested that people seemed to consider an annuity a “gamble” that they would live to an old age instead of realizing that “the decision to self-manage your retirement wealth is the risky one.”  

As people live longer than previous generations, they are more likely to run out of money before they run out of time on the earth.  

The biggest objection that I see to annuities is that people are afraid to tie up their money. Thaler confirmed what I had long suspected. People are much better off restricting access to their money than having full access.  

Another big objection has to be the crumbling faith of Americans in large institutions.  In the book Eat, Pray, Love, author Elizabeth Gilbert references Luigi Barzini’s The Italians in explaining why a country that has “produced the greatest artistic, political and scientific minds of the ages” has not become a world power.

Barzini’s conclusion is that after hundreds of years of corruption and exploitation by foreign dominators, Italians don’t trust political leaders or big institutions.   

Gilbert said the prevailing thought is that “because the world is so corrupted, misspoken, unstable, exaggerated and unfair, one should only trust what one can experience with one’s own senses.”      

If the mindset of the United States becomes more like the Italians, the concept of thinking long-term will be harder and harder to achieve.  

An annuity is just one tool, just like balancing your money among a number of different investments, but the key to wealth is to develop good savings and spending habits.  

I’ve had a successful career in the structured settlement business, primarily because I believe so strongly in the concept. When I meet potential clients, they sense my passion and enthusiasm.  Several years ago, I worked with a large number of people who were injured or killed in the same accident. About half of the people who received money took some of it as a structured settlement. The other half took money in a lump sum.  

I kept up with the group closely. The details of the settlements are confidential, but I don’t think that anyone who received a lump sum still has any of it left. Most ran through it in a couple of years. The people who took the structured settlement are very happy. I keep in regular touch with some of them, and they frequently thank me.  

Not everyone agrees with Thaler about annuities.   

When Brett Arends was at the Wall Street Journal in 2008, he wrote a column titled “Take the Money and Run.” He said that lottery winners should take the lump sum instead of annual payments.  

It was terrific advice for someone who lives in a vacuum or on a desert island. It was bad advice for lottery winners.  Arends made some economic points. He said that taking the lump sum now would net more than normal. Many lotteries base their lump sum calculations on U.S. Treasury Bonds rates. Arends assumed that taxes will be higher in future years. It is a 50/50 guess.  

Anders noted that taking the lottery payments over 20 years would net a 5.7 percent rate of return. In a year when the stock market was  in free fall and foreclosures everywhere, 5.7 percent doesn’t sound so bad. Not to Anders. He had one word to describe it to describe the 20-year payout. “Yuck.”  

This rate would look good to those who blew their lottery lump sum. Right now, they have zero.  

Anyone getting a guaranteed return of 5.7 percent in 2012 would be jumping for joy.  The biography of Arends said that he had been living in London. He might have missed an American idea called dollar cost averaging.  The concept is simple: Instead of dropping all your money in the market at once, you invest over time, like on a weekly or monthly basis. The returns are usually better than timing the market.   

Annual payments from the lottery set up perfectly for dollar cost averaging. If a person was smart and invested each year, the ultimate returns should not cause an observer to say “Yuck.”  Anyway, we have established that I am passionate about lifetime annuities.    

People who are getting a lump sum need to feel that same kind of excitement.