Lump Sum Vs. Life Annuity for a Pension Payout

by Geri Terzo
A spouse generally continues to receive annuity payments even after the retiree dies.

A spouse generally continues to receive annuity payments even after the retiree dies.

Although most Fortune 100 corporations offer employees defined contribution 401(k) retirement plans, according to a study performed by retirement consulting firm Watson Wyatt cited in a 2009 article on the "USA Today" website, employees may still have their entire retirement benefit wrapped up in a traditional defined-benefit pension fund. Pension features vary, although they generally allow employees to make pretax contributions from their salaries to help fund the plan. When it comes time to retire, you may be offered a choice between a lump-sum payment or annuity-style distributions. If faced with such a decision, you should evaluate several factors, including how involved you want to be in managing the money.

Overview

Your human resources department can help you determine the size of a pension benefit, whether a lump-sum payment or monthly, annuity-style payments. A lump sum represents one large, upfront payment, while annuity-style distributions are generally paid monthly for the remainder of a retiree's life. The value is a result of the size of contributions made by an employee and the employer, as well as the performance of the plan's investment portfolio. Nearly three-quarters of workers at least 55 years old prefer to have control over their benefit and opt for the lump-sum selection, according to a 2007 study performed by Vanguard Group and cited in a 2011 "Kiplinger" article.

Predictability

One of the benefits of receiving a life annuity as a pension payout is the predictability of the distributions. Although it may be difficult to foresee expenses such as health care costs for the remainder of your life, annuity payments provide some stability. With a lump sum, you are responsible for managing the money or hiring a professional money manager to invest the assets. Whether that provides more money for you in the long run depends on the amount of the annuity payments and how well your lump sum is invested.

Risk

A drawback with an annuity-style payout of pension benefits is that the income is a set amount and does not change to keep pace with inflation, according to a 2010 article on the Bankrate website. Annuity payments are also calculated based on interest rates at the time of retirement, and a low-interest rate environment would result in lower monthly payments. Should you decide to take a lump-sum payment, it's wise to place it in an individual retirement account, according to a 2012 article on the "U.S. News and World Report" website. Investing in an IRA will protect the tax-deferred feature of the income.

Future Changes

Usually, the decision between an annuity and a lump-sum payment is a final one. In 2012, that line was blurred by automaker General Motors, which emerged from bankruptcy in 2009. The company offered retirees — workers who previously opted for the annuity-payments — to reconsider the lump-sum option, and also offered revised features on the annuity. GM set a precedent in offering retirees these options.

About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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