Receiving a lump sum payout from an insurance policy that provides lump sum disability cover or the Compensation Fund or any other source, may make you feel like you have won the lottery. However, if you need to live off this money for the rest of your life, proceed with caution.
Spending blindly can result in your money running out quickly. It is essential to be aware of the percentage you are withdrawing from your lump sum.
For example, if you receive a lump sum of R1 million, it may seem like a lot. But if you invest this to earn a return of eight percent a year and draw R20 000 a month, you will have nothing left after five years.
Withdrawing a R20 000 monthly income from R1 million equates to a withdrawal rate of 24 percent of the capital a year, which is not sustainable. Your withdrawal rate depends on your return and life expectancy, but withdrawal rates above five percent a year have been shown to be difficult to sustain for long periods even when you earn returns in excess of what you draw.
It is critical therefore to plan how you will spend a lump sum of money to ensure that it can sustain you for as long as you need it. Life expectancy has increased across the world and can play a major role if underestimated.
Before making any decisions, take stock of your finances. List your debts and create a realistic budget so you understand your monthly financial needs.
Then consider using some of the cash to settle your debts, especially expensive debt such as credit card debt and an overdraft.
If you can, consider using some of your lump sum to settle bigger debts such as your home loan or vehicle finance, and reducing your budget for the savings you will make when you no longer need to make the repayments. This will save you a lot in interest repayments. However, before you reduce the lump sum which will generate your future income stream, seek financial advice.
Ensure that you set aside an amount – equal to four months fixed expenses - in an emergency fund. Also consider any home modifications you may require, such as wheelchair ramps.
Then calculate what income the balance of your cash sum will generate for the rest of your life. When you have established this, you may want to rethink how much you should allocate to home modifications and other immediate needs. Redo the calculations until you can provide for a reasonable income and pay down as much debt as possible.
Inflation will quickly erode any income you draw from a lump sum, so your planning must provide for the income to increase annually.
While higher investment returns can increase the longevity of your money, it comes with higher investment risk and volatility, and you need to be sure you understand and are 
comfortable with this risk. When your investments in financial markets are showing losses and you continue to draw a regular income from the reduced lump sum, there is a risk that you deplete your capital to such an extent that it can no longer provide the income you need, even when markets recover. This is known as sequence risk and if you invest in financial markets, it is wise to get ongoing help to ensure that you can live off your investments for the rest of your life.
Where you will invest your money. Some options are easier to understand, such as a savings account with a fixed interest rate, but these options may not provide protection against inflation.
Tax implications vary depending on the investment and this may affect your income.
Making the investment decisions alone and without the help of a suitably qualified professional adviser is risky – you may need to consult annually with a professional financial adviser who can assist you to determine a sustainable level of income to draw from your investments.
Whether you will continue to save for your retirement or if you need the lump sum to replace the retirement contributions you will no longer make because you are not working.
Fixed deposits, money market funds, or RSA Retail Bonds may seem like safe places to invest a lump sum and you can draw the interest monthly as an income in most instances – make sure of this before committing your funds for a fixed period.
RSA Retail Bonds provide a predetermined interest rate if you commit to investing for a period. With some, but not all, of these bonds you can be paid the interest out monthly. Also be sure to check about access to your capital in an emergency to avoid penalties.
In a money market fund, the interest will fluctuate with the prevailing interest rates. In a fixed term savings product, you will get the interest rate for the term, but you may not get the same rate when you reinvest at the end of the term, as the interest for each term depends on the prevailing interest rates.
While these products may be good for savings you plan to use over the short term, using these products to provide an income over a long period is generally not a good idea as they typically don’t beat inflation over time.
For example, assume you invest R1 million in a fixed deposit for three years when the interest rate is nine percent. You will earn R7 500 in interest each month for the three years, but there will be no increases in your income to compensate for inflation each year.
At the end of the three years you have only R1 million in capital but it’s buying power will be considerably less than it was when you invested because of inflation.
In addition, if interest rates decrease over the three-year period, when you reinvest, you may be forced to do so at a lower interest rate – for example, eight percent. This will reduce your income from the interest to R6 666 a month.
Ensure that you understand the difference between compound and simple interest rates and which applies to your deposit.
You can use a lump sum to buy a voluntary purchase annuity, which can guarantee you a fixed amount for a fixed term or for the rest of your life.
Using a guaranteed annuity that will provide an income for life means you have no investment risk because this is a contractual agreement with a financial services provider, typically a life insurer. The insurer takes on the risk that if you live longer than expected, it will have to continue paying the agreed income.
You cannot specify your desired income. The product provider will provide a quote based on the amount you invest, your age and other factors such as the prevailing interest rates.
There are times when guaranteed annuities offer good incomes and times when they seem low compared to the returns you could earn by investing. However, you should remember that the peace of mind that comes with being certain you will receive an income for life is very valuable.
You will be offered the choice of either a level annuity with no increases, or an escalating annuity with a fixed increase each year or one linked to the inflation rate. Choosing a level annuity will initially provide a higher income but inflation will erode its value and the escalating one will soon prove more valuable as it will offer some protection against inflation.
Once you have invested your money into a voluntary purchase annuity, you can’t change your mind; the contract is permanent. You are no longer the owner of your capital, but will only have a right to the contracted income.
As part of the voluntary annuity income you receive is the after-tax capital you invested, a portion of the income received will be exempted from income tax. This is determined by a set formula.
To ensure that you don’t outlive your money and the income you draw from your lump sum keeps up with inflation, your investment return should outperform inflation over the long term.
Unit trusts and other market-linked investments can provide inflation-beating returns, as they may invest in shares and other financial instruments that potentially offer long-term capital growth.
However, these investments come with some risk – as they can also deliver losses or returns below inflation in some years. It is important to have a long-term investment view to reap the benefits of these investments and not make short-term emotional decisions.
You can schedule regular withdrawals based on your income needs from these investments. However, you run the risk of running out of money if you withdraw too much, or your investment return doesn’t meet your expectations.
Knowing how much money you can regularly withdraw for the rest of your life hinges on four elements:
You will most likely need help calculating how much you can safely withdraw, based on 
assumptions for your investment return and annual withdrawal increases. When drawing an income from an investment, there is also risk in the order or sequence in which you earn the returns. Drawing during a protracted period of low or negative returns can run your capital down to such an extent that it never recovers sufficiently to sustain the income level you want.
Compare how long the money will last to how long you think you will live (taking increasing life expectancy into account). Be careful when making assumptions as even a small variation can have a massive impact in the long term.
Deciding how to invest a lump sum for a sustainable income is complex. A professional financial adviser will be able to guide and assist you, ensuring that you have covered all aspects in your planning. Making a mistake when investing your lump sum can cost you dearly in the long run, so you need to make the right decisions the first time.
