If you’re wondering whether it’s better to give or receive one large lump-sum payment up-front or monthly spousal-support payments, the answer depends on whether you are paying or receiving support.
Here are some pros and cons to consider, from the perspective of the person who would be paying:
Pros for the Spousal Support Payer:
- You will have no continuing obligations to your former spouse;
- A lump-sum payment should reflect a reduction for the time-value of paying the lump sum as opposed to paying spousal support over time. This should reduce the amount of the lump sum; and
- Paying a lump sum removes the possibility that the other spouse will require you to maintain life insurance to safeguard the alimony in the event of your death.
Cons for the Spousal Support Payer:
- You may not have the financial resources to make a lump-sum payment;
- Making a lump-sum payment will not qualify you for an alimony deduction. As a result, you would want to reduce the amount of the lump sum to reflect the fact that you are not getting a tax deduction. Your former spouse may disagree as to the amount of the reduction, because each of you will likely be in different tax brackets. This will generally result in you getting less than the full increase in your income taxes as a reduction;
- You may have the borrowing ability to make a lump-sum payment, but the interest charges on such a loan are usually non-deductible, thereby increasing the cost of the transaction. In addition, the principal payments will result in no tax benefit, again increasing the cost of the transaction if you borrow; and
- Spousal support ends upon the death of the receiving spouse and generally ends upon the remarriage or cohabitation of the receiving spouse. If you make a lump-sum payment, you are foregoing the possibility that you might have a termination of your obligations, which results in the cost of the lump sum increasing versus paying spousal support.
Here are some pros and cons from the perspective of the person who would be receiving:
Pros for the Spousal Support Recipient:
- If you don’t trust your former spouse to make reliable monthly support payments, a lump-sum payment will remove this issue. However, there are ways to collateralize spousal-support payments and significantly reduce this risk;
- You can earn income on the lump sum greater than the discount rate that was used to reflect the time value of receiving the lump sum as opposed to receiving spousal support;
- You have immediate access to the funds. This allows you to possibly acquire a residence instead of renting, or possibly pay off high-interest-rate debts that you otherwise would have to pay over time.
Cons for the Spousal Support Recipient:
- Unless you are adept at cash management, including how to invest your lump-sum payment, you will risk consuming your money faster than if you received monthly spousal support; and
- While it is a remote issue, in the event your former spouse declares bankruptcy after the divorce, his/her creditors may, under certain circumstances, attempt to recover all or a portion of your lump-sum settlement for their benefit.
Each case, of course, has its own unique aspects; what works in one case may not work or even be appropriate in another. Your attorney and a competent matrimonial accountant can help you evaluate whether you should consider a lump-sum payment.
Henry Guberman (CPA/ABV, CFF, CFE, CDFA) is a partner in the Baker Tilly accounting and advisory firm’s forensic, litigation, and valuation services group. His career in public accounting spans more than thirty-five years with a wealth of invaluable experience and a focus on valuation and litigation support services.