Sure, most of us wouldn’t turn down an extra source of income – but that doesn’t mean that having an additional payment stream from an annuity is always a walk in the park.
Managing payment streams is starkly different from spending traditional income sources. They require careful consideration from a financial planning standpoint, and that’s one reason some people approach them differently than other forms of income.
Barbara Friedberg, author and former portfolio manager, said understanding payment streams comes from a behavioral finance concept called “mental accounting.”
For instance, structured settlements owners often get larger payments in addition to their monthly payment stream. Often those are structured with the owner getting say for example $1,000 a month, with a larger payment of $5,000 every 5 years.
“An individual might view income from a paycheck, differently than money from an annuity,” Friedberg said.
Mental accounting is mental gymnastics we do when we get money we didn’t expect and use the source of the money as an excuse to use it more frivolously than we normally would.
That mindset can lead to poor financial decisions. In the case of the structured settlement owner, this could make them feel overly comfortable accumulating high interest debt because they know they can pay it off when their larger payments arrive. However, this traps the person in a loop of acquiring high interest debt and then paying it off – wasting a good portion of their payment on finance charges.
As Investopedia puts it, mental accounting has “an often irrational and detrimental effect on consumption decisions and other behaviors.”
It’s a mistake to view a payment stream exclusively as extra or throw away cash, Friedberg said.
“Don’t look at your annuity income as a windfall to be squandered, but as money to add to a sensible financial plan,” she said. “In other words: Don’t blow it!”
Bring in the Experts
That sensible plan doesn’t have to be something you make on your own, according to Bryan Slovon, founder and CEO of Stuart Financial Group. He recommends getting help from a professional, especially in the case of retirement annuities.
Most people with payment streams need guidance on managing their budgets – and the streams – so that the additional income can be used for the purpose intended, like retirement living expenses or medical bills following the awarding of a structured settlement.
If possible, before even purchasing an annuity, someone in this position should know the ins and outs of what they’re getting themselves into Slovon said.
“With an annuity, once properly structured, you can guarantee income not only for your life, but for your spouse as well,” Slovon said.
Slow and steady wins the race when it comes to financial planning.
Slovon said the worst mistake someone can make is committing to an income stream without consulting carefully with a fiduciary advisor to review their entire financial situation.
“Once these monies are committed to a settlement there is no longer a lump sum of monies, just whatever payout you have agreed to in the contract,” he said.
Then, once the stream of payments starts, Slovon said it’s important to keep checking in with their advisor.
“Someone already receiving annuity income in retirement should be meeting with their fiduciary advisor to review their entire financial situation at least on an annual basis,” he said.
Pitfalls and Mistakes
In the same way you don’t want to live paycheck to paycheck, you shouldn’t be living annuity payment to annuity payment. For many, annuity payments are meant to pay for living expenses, but be prepared for unexpected money needs to come up.
“Always make conservative income projections when making financial projections,” Friedberg said.
You never want to be in a situation where necessities like mortgage payments, credit card bills and taxes go unpaid. The consequences of mismanaged financial projects can last for years in the form of bad credit scores and, as a result, higher finance charges across the board in the form of higher interest rates and deposits.
For instance, take the former example of a structured settlement owner who gets $5,000 every 5 years. When you take into account that the average American has $15,263 in credit card debt, a 33% APR due to missed payment could cost you $5,036 in finance charges in a year – which in one year eats up the whole payment they were expecting for five years.
The best thing to do is to sit down and plan a safe, manageable budget to avoid making critical money mistakes.
“A lot of the time, people get into a spending mindset or feel burdened with the responsibility of managing the money,” Slovon said. “But at the end of the day, the most important thing is to take your time.”
Still a Solid Option
Annuities tackle two big fears among retirees: running out of money and losing money in risky investments. And for structured settlement owners, they can be a secure financial base after unfortunate life events. Both types of owners should feel confident in their financial outlook and empower themselves to put their payment streams can be put to good use.
“In general, when you receive a payment stream from an annuity or structured settlement you know how much you’ll receive and when,” Friedberg said. “With income from other sources, such as dividends or capital gains, the amount may be uncertain.”
That certainty makes annuities a wonderful asset Slovon said.
“Payment streams like structured settlements or immediate annuities can be great tools in one’s financial toolbox,” Slovon said. “They can guarantee cash flow for the rest of a person’s life – no matter how long they live.”