A Lump-Sum Pension Or Annuity– Which One Is Better?
This is the nerve-wracking question every employee has to face before they retire. By taking a lump sum, you receive your pension amount all at once. Meanwhile, an annuity ensures monthly payments till your death, or in some situations, even after your death to your spouse.
A lump-sum, no doubt sounds tempting, as you receive a huge amount more than enough to use in any manner. You can travel, make investments, buy a property, start a business, or do anything with it. However, it is also very risky, because then you will have no other source of income after retirement. Moreover, it’ll totally be up to you how successfully you use a large amount of your pension.
In this dilemma, what would you choose?
Types of pension funds
There are majorly two types of pension funds, traditional or defined-benefit plans and 401(k) or other defined-contribution plans. A traditional plan means that there will be a specific amount that your employer will have to pay upon your retirement.
On the contrary, a defined-contribution plan promises no such guaranteed payment. Rather, it will let you contribute and make investments into your retirement fund.
From the employers’ point of view, traditional or defined-benefit pensions are often a huge risk. This can make companies pay retirees for the rest of their lives. Therefore, employers often suggest a lump sum payment to cut expenses, as this way they’ll be paying only once. But, as an employee, is this favorable for you too?
Reasons why most retirees prefer lump-sum over annuities?
Though the big amount is tempting itself, this is not the only reason why some retirees prefer a lump sum. A lump-sum payment is safer, comes with great prospects, and permits a guaranteed amount. Additionally, there are several other reasons and conditions that make lump-sum pensions more preferred
- If you are not certain about the company’s future or its financial health, you better choose the lump-sum payment option. Some pension funds are extremely underfunded. In such cases, there lies no assurance when your employer may stop your monthly pension amounts. Before you opt for an annuity, you must check the financial condition of the company. Moreover, you also need to take an annual update from your pension fund. You must have knowledge of the plan’s current assets and liberties, along with the percentage of funding. Though annuity won’t just become completely useless when your pension plan fails. Pension Benefit Guaranty Corporation will take care of it, still, you won’t receive everything.
- The second most important reason why you should choose a lump sum amount is the maximum pension benefit. You would obviously want your spouse to receive the 100% of the monthly pension amount after you die. However, some funds will only deliver 50% or 75% of the original pension.
- Thirdly, monthly pension plans may not allow you to take a portion when it’s an emergency. In this case, you should just take the lump sum amount option.
Other roots of retirement income after taking a lump sum amount
When taking a lump sum amount instead of the annuity payments, you may not face the situation of withdrawing money from your IRA or 401(k) plan before you need them. Sometimes it is a wise decision to withdraw these funds before the need arises. However, with a monthly pension plan, it may lead you to pay higher tax bills. By accepting a lump sum amount, you can postpone the withdrawal from accounts where they will be taxed at a rate of full federal and state income tax.
What are the reasons to consider an annuity for your retirement?
What’s next after receiving your lump sum amount all at once? Do you have other options for income after retirement? Or are you completely dependent on your one-time pension fund?
What after all your money runs out?
The lump-sum money can run out in months but you have a long life to live. The longer you live, the higher the chances of your money pot drying out. In this case, the only way to rely on your lump-sum pension is to reinvest it. However, reinvesting your money if you don’t have another source of income, can be a little risky. One wrong move and you can experience a huge loss along with a great financial crisis.
What will happen to your partner when you’re gone?
You will also need to plan what will happen to your spouse after your death. When someone dies, the whole pressure of domestic expenses comes straight on his or her spouse’s shoulders. Thus, having an annuity can be great from this point of view. It will pay your partner till the date they are alive and will help prevent tough times even in your absence.
What should you choose then?
The points mentioned above don’t take the lump sum payment less advantageous. You can learn and try to invest and manage this money in a way that suits your condition better. Moreover, it will allow you to save for later emergencies. However, for that, you will need to have other income streams like Social Security and other contribution funds.
Whatever you choose as a pension payment plan, the guaranteed income should cover the essential monthly costs. If anything’s more than that, you can increase it through investments and money management.
Additionally, you need to prepare in such a way that ensures a steady stream of income as you grow old. As you’ll grow older, you’ll not be able to manage your investments with much energy and efficiency. Thus, having an annuity for that time can help you greatly.
The bottom line
Well-thought planning and management are the keys to a successful after-retirement life. You can take a lump sum amount and reinvest it into a more steady annuity for your future. Moreover, you can secure a portion of it for medical and other such emergencies (more likely as you age). This will ensure a comfortable retirement life for you and will keep both your monthly expenses and emergency funds sorted.
