When you have a pension and retirement looms, you must make some decisions. The question is, should you take one lump sum or an annuity?
Pension Annuity Lasts a Lifetime
An annuity means your pension will be paid monthly for your remaining life. An annuity is a guaranteed income and does not vary because of market performance. Although the amount is fixed, some plans have a cost-of-living adjustment (COLA). But check your plan because not all companies offer a COLA.One Lump Sum Invested
A lump sum is a one-time payment. You will not receive a steady stream of monthly installments throughout your lifetime.Income and Taxes
An annuity doesn’t vary with market fluctuations. The investment remains with your company. If there is a downturn in the market, the company will have to add additional funds to the pension to make your installment payments.If you receive a one-time lump sum, you can invest it and possibly increase its worth—but you also incur the risk. If there is an unfavorable fluctuation in the market, you could lose your nest egg.
Pension payments are taxable income. You will be taxed on the entire amount if a lump sum is taken. The exception is if you roll over the funds to an individual retirement account (IRA) or another employer-sponsored retirement plan.
If the lump-sum payment is high enough, it might push you into a higher tax bracket. You should check with an accountant before making a decision.
Your age is a factor. If you take the lump sum before you reach 59½, you may be subject to a ten percent early withdrawal penalty. This is in addition to the taxes.
Life Expectancy a Factor
Consider your health and expected lifespan when making a decision. If you are in good health and expect to live a long time, annuity payments might be your best decision. Throughout your life, you will have monthly payments. You cannot outlive annuity payments.Family Affected by Choice
Will your spouse need support after you’re gone? A lump sum could be invested to help secure your spouse’s future. It can also be left to your beneficiaries. Check with a financial advisor and determine what returns you would receive by investing.There are usually some options with an annuity. For example, you can do a 50 percent joint survivor annuity if you have a spouse. The monthly payment will be lower while you both are alive, but your spouse will receive payments after you pass.
If your spouse passes first, you can usually return to full payments.
You also could do a 100 percent joint survivor. A lower than 50 percent payment installment will go to you monthly, but your spouse will receive 100 percent once you pass.
Another type of installment is a single-life payment. This usually pays the highest. But when you pass, your beneficiaries do not receive any payments—the payments only last while you live.
Company’s Financial Stability
Check the credit rating of your company if you are considering an annuity. If your company is experiencing financial problems, they may default on their pension fund obligations.Pros and Cons of an Annuity
With an annuity, you receive a monthly benefit for life. From a psychological and financial planning aspect, this is comforting. It’s like keeping your paycheck going. You also may be able to provide security for your spouse.Pros and Cons of One Lump Sum
A lump sum can be used to pay off all debts, and you can pass some on to your heirs. You also have the flexibility of investing and growing the principal.Although you have the flexibility to invest, you could also lose the funds if there’s a downturn.
An Annuity vs. Lump-Sum Payment
Consider your circumstances and risk tolerance when deciding on an annuity or lump-sum payment.It would be wise to consult with a financial advisor and tax attorney. But check the financial interests of those advising you and ensure they have your best interests at heart.
This is a lifelong retirement you’re considering; take your time when deciding.