Lump Sum Vs. Annuity

social security benefits man sitting reading a book

If your employer offers a defined-benefit plan, otherwise known as a pension, you will be able to start receiving your retirement benefits after you have stopped working. This will help in your goals for your golden years and assist in maintaining the quality of life that is acceptable to you in retirement. However, at the time of retirement, you will be faced with an important decision to either take your retirement benefits in a single lump sum payout or receive a regularly occurring annuity payment.

Difference between lump sum and annuity
Choosing a lump sum will enable you to receive all the funds accumulated in your pension account right away in a single payment. On the other hand, going with the annuity option will provide you with multiple payouts which could be weekly, monthly, quarterly, or annually.

Advantages of a lump sum payment
Choosing a lump sum payment gives you control over how your money is invested and what happens to it once you’re gone. To avoid paying tax on the entire amount of lump-sum income, the funds need to be rolled into a traditional IRA account. If invested well, the funds can continue to grow until you are ready to begin withdrawing.

Disadvantages of a lump sum payment
Of course, there are also disadvantages and risks associated with choosing a lump sum payment from a pension upon retirement. As mentioned above, if you cash out the money, it will be considered taxable income and you could have a very sizeable tax bill. You also risk spending all the money, and that could be a problem if you need that income for living expenses during your retirement.

Advantages of an annuity
Instead of a lump sum you may decide to go with an annuity which has its own advantages that should be considered. With an annuity you will be able to count on having a steady stream of income through your retirement years. Also, you will be able to pass along this income to a spouse or another heir.

Disadvantages of an annuity
On the other hand, there are disadvantages to choosing an annuity which you may want to be aware of when planning your retirement. With an annuity you will have less flexibility from a financial perspective. Also, there is a possibility that you will pass away before collecting all your accrued benefits. There are some annuities that will not pass leftover funds along to other beneficiaries in the case of your passing away. Additionally, if you have a serious illness or medical condition, the annuity payments may not be enough to cover your medical expenses.

Should you choose a lump sum or annuity from your pension?
Whether you choose a lump sum or annuity is an important decision to make when deciding what to do with your pension upon retirement. You will want to consider your life-expectancy which can depend on whether or not you are relatively healthy. Also, how much income you have from other investments and retirement accounts should be considered.

Any opinions are those of the author and not necessarily Raymond James. Any information provided is for informational purposes only and does not constitute a recommendation. Prior to making an investment decision, please consult with your financial advisor about your individual situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we do not provide advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.