Choosing between an annuity payout and a lump sum requires careful consideration. Review your current and projected future financial situations, including debt and post-retirement income. Evaluate the length of time you'd need to receive annuity payments until the income equals the amount of the lump sum. No right answer exists; the individual factors involved vary from person to person. Due to the complexity and idiosyncrasies of annuity payout options, you may benefit from a consultation with a financial adviser before making any payout decisions.
Situations
A common situation in which you may have the choice between a lump sum and an annuity is a defined benefit pension plan. Not all pension plans offer both options, however. You will also have a lump sum or annuity option on your own annuity or if you are the beneficiary of an annuity plan. Additionally, if you are lucky enough to win a lottery, you often have the option of an annuity or a lump sum payout of your winnings.
Annuity Advantages
Annuities pay you a fixed annual income for a certain length of time. For most pension and annuity plans, the payout is your lifetime; states pay out lottery winnings for a specific number of years. The annuity option guarantees you have money coming in every year, which may be helpful if you're on a fixed income.
Lump Sum Advantages
Lump sums can provide a large influx of cash at one time, which may be helpful if you want to pay off your mortgage or send your grandchildren to college. Taking the lump sum and investing it gives you direct control over the asset allocation, and you can restructure your investments as your situation changes. You can potentially earn more over time than you would make with some annuity options.
Annuity Disadvantages
Pension and lottery annuities typically have a fixed or flat rate of return and are not indexed for inflation. Annuity payouts are also subject to future tax rate changes. Your annuity payments may be at risk if your former employer goes bankrupt, although the Pension Benefit Guaranty Company guarantees most pensions.
Lump Sum Disadvantages
You must pay tax on a lump sum in the year you take the distribution, which may result in a significant amount of tax due. A pension lump sum payment qualifies for a rollover into an individual retirement account, which lets you defer paying taxes until you withdraw the funds. If you invest all or part of the lump sum, your entire investment is at risk and subject to the fluctuations of the stock market.
Member Comments