Lump Sum vs Annuity Pension: Which Is Best?

Revised April 18, 2019

Every few weeks someone comes to us with questions about an annuity product or pension elections.  We routinely evaluate the various plans and are often baffled by the amount of complexity embedded in the selection process.  Every individual and family is unique, as are their financial needs and concerns. You may already have annuities in addition to your annuity from the social security administration. You may have specific tax issues or estate concerns. Before you make an irrevocable decision, consider the impact on your financial future, as it will have a direct impact on future income, taxes, insurance needs, investment choices, and estate planning.

One of the most common questions we hear is “Should I take a lump sum payment or monthly annuity?” If you are nearing retirement and will soon need to review your investments (or if your employer is making changes to your company pension plan), you may well be asking yourself the same question.

What’s the difference? In short, a lump sum from an annuity product is a one-time payment with which you can spend or invest how you please. If the lump sum is from an employer pension plan (defined benefit plan), you can roll it into your 401(k)/403(b) (defined contribution plan) or an IRA. Conversely, the annuity option offers you steady income over an extended period of time, usually for your lifetime or a certain number of years.

At HSC Wealth Advisors we have compiled a list of advantages and disadvantages concerning both sides of the decision.

Advantages to Choosing the Lump Sum Over Annuity Payments

Some people choose the lump sum simply because they prefer to receive their money upfront. Here are several additional advantages of choosing the lump sum over the annuity payments:

1)      Social Security – You will receive this U.S. Government inflation-adjusted annuity at your qualifying age.

2)     Investment Choices – If properly invested, the lump sum may grow and outpace inflation. In fact, you can make strategic choices of how to invest the lump sum, so it grows enough to achieve your goals and fund your lifestyle.

3)     Taxes – If rolled into a 401(k)/403(b) or traditional IRA, you can continue the tax-deferral into the future.

4)     Strategic Maneuvers – There is opportunity for Roth IRA conversions. This option allows you to convert portions of your lump sum payout to a Roth IRA where the investment can grow tax-free, if your tax situation permits.

5)     Flexibility of Withdrawals – You have tax-efficient withdrawal opportunities because you can adjust the timing of withdrawals.

6)     Estate Planning & Charitable Gifting – It may be possible in the future to donate the amount to a charity or leave it to children or grandchildren. With a larger sum, you may have more options.

7)     Annuitize Later – You could grow the money and purchase an annuity in the future when interest rates may be better. If the market currently has low interest rates, it may be better to wait. It’s easier to move from a lump sum amount to an annuity than to cash in an annuity and get a lump sum.

8)     Credit Quality – You won’t have to be concerned with the credit rating or liquidity constraints of the annuity provider or pension fund.

Potential Disadvantages of Taking the Lump Sum

The lump sum may offer you flexibility and open some investment options, but taking the lump sum has its drawbacks too:

1)     Market Downturn – With poor market performance, the sum may not grow as expected. In other words, you may take the lump sum, invest it, and find you would have had a more predictable income stream with the annuity.

2)     Investment Management – Without a trusted financial advisor, you are responsible for managing the money. Are you disciplined and methodical? Do you understand how investments and financial markets work? It may be easier to stick to an annuity or at least hire investment professionals to help you manage the lump sum.

3)     Cash Flow & Accessibility – You run the risk of using it up by withdrawing too much due to easy access. If you struggle with savings and money management or don’t know how to handle large sums, it may be easier to stick to an annuity or hire a financial planner for accountability.

4)     Outliving Your Money – You may live longer than your average life span and have to make the money last longer.

Annuity vs Lump Sum Payout: The Bottom Line

This is your money and your investment opportunity. Selecting an annuity option or the lump sum payout is ultimately up to you. Individuals who prefer the DIY approach might consider taking one of the annuity options.

Key variables to consider in your evaluation:

• Your retirement income needs and expenses;
• Your investment knowledge and money management skills;
• Your time horizon, and
• Your plans for wealth transfer.

If you do decide to take a lump sum, make sure you have personal financial advice tailored to your specific situation as well as the discipline to prevent over-spending. If you need comprehensive financial advice and assistance with your investments, or if you have questions about your specific annuities and pensions, contact HSC Wealth Advisors for a FREE introductory meeting.