$78,000 and $650 per month? How to decide between lump sum and annuity payments
$78,000 and $650 per month? How to decide between lump sum and annuity payments
SmartAsset and Yahoo Finance LLC may earn commission or revenue from the links below.
When faced with the decision of taking a lump sum pension or a monthly annuity, your course of action will depend on your personal circumstances. Key factors include your life expectancy, other sources of income and how soon you can expect to receive your lump sum payment.
Before making any big decisions about your retirement savings, talk to a financial advisor. Contact your advisor today.
Generally speaking, longer life makes an annuity a better option, but if you have the opportunity to receive a lump sum early, the option may be more attractive. Expectations for inflation and investment returns also influence this decision.
Lump-sum options, while generally riskier, also offer more potential upside, depending on your skills as an investment manager and market performance. However, those who are risk-averse or not confident in a lump sum investment may opt for reliable guaranteed annuity payments.
An employer-sponsored pension plan that pays you a guaranteed monthly stipend starting on the date you retire and as long as you live. These payments are guaranteed by the employer as well as the Pension Benefit Guaranty Corporation (PBGC). Many schemes provide a spousal benefit which will continue to be paid to the partner if the pension holder dies. Some also offer inflation protection in the form of payments that adjust for the cost of living.
But employers often offer covered employees the option of receiving a lump sum payment rather than steady monthly payments for life. People who choose to receive a lump sum pension will no longer receive their pension. Instead, employees invest or manage the lump sum themselves.
If the investments perform well, this can result in greater overall financial benefits than an annuity option. A lump sum option may become less advantageous if the lump sum recipient makes poor investment decisions or the market performs poorly.
Generally speaking, a lump sum payment may be a good option for people with poor health and a short life expectancy. It may also make sense for people who don't have a spouse or have other income to put toward retirement expenses. Plans that don't have features like spousal payments and inflation protection may also reduce the value of an annuity option.
However, when to pay the one-time fee is a key consideration. Some companies will pay a lump sum several years before the usual retirement age. If this happens, the one-time investment can be made faster and have more time to benefit from compound interest. Ultimately, this option may result in more money than all annuity payments combined.
However, there are many considerations associated with this choice. This includes taxes, which may be due immediately in a lump sum unless the distribution is rolled over to a Traditional IRA within 60 days of the date. Investment fees must also be considered, as these may impact the performance of a lump sum-funded portfolio.
If you need help evaluating your options and deciding between a lump sum or an annuity, consider talking with a financial advisor.
Imagine you are deciding whether to take a lump sum of $78,000 or a monthly annuity of $650. Your current age and life expectancy are key considerations in this decision. For example, let's say you are 60 years old now, expect to live to age 80, and start receiving benefits when you retire at age 65. This means you will receive 180 payments of $650 for a total value of $117,000. If you live to age 90, the cumulative value of the annuity payments will be as much as $195,000.
If the plan includes spousal benefits as well as inflation protection, it may be worth more. For example, if the annual inflation rate is adjusted to 2.5% and the 55-year-old spouse lives to age 85, the total annuity payment will be more than $266,000 with a spousal benefit of 100%.
Now, let's say you take a lump sum of $78,000. You can receive this money at age 60 and invest it. If you live to age 80, your investments would only need to grow 3.39% per year to equal an annuity value of $117,000, without taking into account spousal benefits or inflation adjustments. For the value of a more feature-rich annuity to match inflation adjustments and spousal benefits, your investment would have to earn 7.56% annually.
Remember, a decision to pay a lump sum is difficult to reverse. Once paid, the employer has no further financial obligations. It is possible to use the money received as a lump sum to purchase an annuity later, but the associated fees mean this may result in monthly payments that are less than the original annuity benefit.
Remember, a financial advisor who provides retirement planning services can be a valuable resource as you make decisions about annuities and other sources of retirement income.
When deciding between a lump sum or a pension annuity, consider your current age, life expectancy and when you will receive the lump sum. If you expect to live longer, this may mean an annuity is worth more. The sooner you receive your lump sum payment, the more valuable this option is likely to be.
Remember, accepting a lump sum payment means the company no longer has any financial obligation to you, and you will be responsible for investing the money to generate an adequate return. On the other hand, if you insist on opting for an annuity, the company takes on the responsibility of making sure you receive monthly payments for life.
A financial advisor can help you manage annuities and other income sources in retirement. Finding a financial advisor isn’t difficult. SmartAsset's free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches for free to decide which one is the best fit for you. If you're ready to find an advisor who can help you achieve your financial goals, get started today.
Inflation is an important consideration whenever you make long-term financial forecasts. SmartAsset's Inflation Calculator can help you understand how the purchasing power of the dollar changes over time due to inflation.
Keep an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid—held in an account that is not at risk of large swings like the stock market. The trade-off is that the value of liquid cash may be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts at these banks.
Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with prospects and provides marketing automation solutions so you can spend more time converting. Learn more about SmartAsset AMP.
