Annuity vs. lump sum

Weigh the options between lump sum and annuity payments.

  • Private Wealth Management

The situation

As companies offer more defined contribution plans, employees are being increasingly called on to be more actively involved in the management of their retirement finances.

But even those employees who still have defined benefit plans may need to choose between a lifetime monthly annuity benefit and a one-time lump-sum payment (sometimes referred to as a "pension buyout").

Making the choice

In light of these facts, here are some key considerations to keep in mind when deciding between lump-sum and annuity payments with the help of a trusted tax, legal, and/or financial advisor:

Life expectancy: Monthly benefit and lump-sum payments are products of actuarial calculations. However, the underlying assumptions in the calculations may not accurately account for an individual’s personal and family medical history. Someone expecting a longer-than-average life span would take comfort from the prospect of a monthly stream of income. Conversely, a shorter-than-average life expectancy might favor a lump-sum payment.

Projected annual income needs: Individuals who already have sufficient income sources—through Social Security, other pension benefits, or a large portfolio— might find an annuity less attractive than a lump sum.

Inflation: Unless the annuity payment contains a COLA provision, that monthly payment will eventually lose ground to inflation. A lump sum, by contrast, can be allocated across asset classes as a hedge against inflation, but this approach also entails investment risk.

Convenience: Managing a lump sum for retirement income requires active involvement in terms of planning, budgeting, and discipline. If an individual is uncomfortable with investing and planning or disinclined to take the time, then a regular, monthly payment may be desirable.

Gift and estate planning: While wealth transfer may not be an immediate concern, it may become important once living expenses are adequately covered. A pension plan doesn’t usually offer the ability to transfer benefits to children or grandchildren. However, a lump sum could provide heirs with additional resources.