Should you take a one time lump sum or annuity payment. Should you spread the payment out over the course of many years?
Believe it or not, you may actually get the chance to make a choice like this. And, you need to have all the facts and understand how your choice can affect your family.
Typically, we think of this choice when a new lottery winner is announced. We all tend to daydream about what we would do with a huge lottery win. It’s okay to dream of winning the lottery.
That dream should also includes how you would choose to accept the winning payout. Is a reduced lump sum payment better? Or, should you parcel out your winnings a little bit each year over the course of 20 or 30 years in the form of an annuity?
Now let’s flip this on its ear a little bit. Imagine the same questions with respect to a life insurance payout, your retirement nest egg, private pension plan, or an inheritance. Now, the chance of having to make this tough choice is a lot more realistic and likely than those dreaming of pocketing those lottery millions.
Benefits Of Taking A Lump Sum Payment
Should you take the lump sum or annuity payments over time? A dollar today is worth more than a dollar in the future. This is true thanks to inflation. It is not that a dollar is worth more because a dollar is always worth one dollar.
But, we can buy more things with money today than the same amount will buy us in the future. So, if you had the choice of a million dollars today, inflation alone would make you want to take it as a lump sum. You wouldnot spread it out over years where your buying power will be reduced.
Having your entire lump sum immediately also puts the investing decisions in your own hand. When you choose to take your winnings or payout in an annuity over the course of decades, you are letting others invest your money however they want.
They can reap huge benefits if their investments with your money increase on still only have to pay you the set yearly payout amount of your annuity.
Drawbacks Of Taking A Onetime Payment
Taking the money in one lump sum payment can have some dangerous consequences. There is the potential to spend the money frivolously if you receive it all at once.
And, of course, once it is gone and spent foolishly, then it is impossible to get back. Another drawback to receiving a onetime payment is that you will typically receive less money today than you would receive when you add all of the annuity payments together.
Why Consider Monthly Payments
A lump sum payment may not be for everyone. There are several reasons why you may want to consider taking monthly annuity payments instead of a lump sum.
If you don’t have discipline not to waste a large sum of money, then you may be better off having a company pay you monthly or yearly sums over the course of decades. Also, taking annuity payments instead of a single lump sum will allow you to receive a larger total over the course of the payments when added together because lump sum payments are much smaller than the amount won.
The Dangers Of Monthly Annuity Payments
It is not simple to just choose the monthly or yearly annuity payments either though. They have their own set of drawbacks as well. When you choose to take payments a little along, the money is worth less in the future when you receive it than it would be had you received it today.
The bank, insurance company, lottery, and others actually keep your earnings and provide you a set return on the investment that they now own instead of you even if they earn a higher rate of return than your annuity payment.
Another drawback of monthly payments are the low interest rates that we have seen for years now thanks to the Federal Reserve’s policies. Lump sum payments are worth more and larger in low interest rate environments.
And, finally, what if you outlive your payment schedule? You will need to check the fine print to make sure that your heirs receive your payments should you die before the end of your collection period.
It is not as cut and dry a decision as to whether you should take a lump sum payment or monthly payments in the form of an annuity. They each have their own benefits and drawbacks like most financial decisions we all face.
You have to make the choice that is right for you and your family, based on your goals, and with the understanding of all the consequences of your choice.
Wouldyou take a one time lump sum or annuity payment?
FAQs
While an annuity may offer more financial security over a longer period of time, you can invest a lump sum, which could offer you more money down the road. Take the time to weigh your options, and choose the one that's best for your financial situation.
Is it better to take annuity or lump sum? ›
Most experts would agree that, for most retirees, a guaranteed stream of income for life is a better option than a lump sum.
Which is better lump sum or monthly payments? ›
In most cases, the lump-sum option is clearly the way to go. The main difference between a lump-sum and a monthly payment is that with a lump-sum option, you get to have control over how your money is invested and what happens to it once you're gone. If that's the case, then the lump-sum option is your best bet.
Should I take a $48000 lump sum or $462 monthly payments for a pension annuity? ›
Lump Sum Value Is Based on Payout Date
Then, at $462 a month and $5,544 annually, you need to reach 8.65 years to have the pension payments break even with a $48,000 lump sum payment. "In this simplified scenario, when the retiree's life expectancy is less than 8.65 years, the lump sum would be preferred," Bryan M.
How much does a $300 000 annuity pay per month? ›
Here's how much income a $300,000 fixed annuity might pay per month: $3,517 if you choose single life only, which allows you to receive income for life but does not offer a death benefit to your beneficiaries.
What is the biggest disadvantage of an annuity? ›
High expenses and commissions
Cost is one of the biggest drawbacks of annuities.
What is the 6% rule for lump sum pension? ›
To determine this number, consider the 6% rule: which states that if your monthly pension offer is 6% or more of the lump sum offer, you should choose the perpetual monthly payment option. If the number falls below 6%, you might do as well (or better) by taking the lump sum and investing it yourself.
Why are lump sum payments taxed so high? ›
Since your regular pay and bonus pay are combined, the amount of tax taken out is on that higher lump sum because of the way your yearly salary, and therefore your tax bracket, is calculated in that paycheck.
Will my monthly payments go down if I pay a lump sum? ›
Will my mortgage payments go down if I pay a lump sum? Your recurring monthly mortgage payment will remain the same even when you submit an additional payment or lump sum unless you recast your loan.
What is better than an annuity? ›
In general, 401(k) plans — and the very similar 403(b) plans offered by nonprofit organizations — are a better way to grow your cash for retirement than an annuity.
A straight fixed annuity is the easiest type of annuity to calculate a payment from. This is because fixed annuities work like bonds. If you use $50,000 to buy a fixed annuity paying 5% per year, for example, you'll earn $2,500 annually or about $208.33 per month.
What is a good amount to have in an annuity? ›
No annuity strategy, however, can keep pace with inflation quite like investing directly in the market. That's why Pfau recommends putting no more than 20% to 40% of your retirement savings into annuities. The rest of your portfolio should remain in market assets for inflation protection and easier access to the money.
Is $6,000 a month a good pension? ›
With $6,000 a month, you have more money than the average retiree—Americans aged 65 and older generally spend roughly $4,000 a month—and therefore more options on where to live. Below, we list five spectacular places where you might consider spending your golden years.
Do you pay taxes on an annuity? ›
Because annuities grow tax-deferred, you do not owe income taxes until you withdraw money or begin receiving payments. Upon withdrawal, the money will be taxed as income if you purchased the annuity with pre-tax funds.
How much does a $100 000 annuity pay per month? ›
A $100,000 immediate income annuity purchased at age 65 could provide around $614 per month. With a 5% interest rate and a 10-year payout period, the same annuity might pay approximately $1,055 monthly. At age 70, a similar annuity could offer a lifetime payout of around $613 per month.
How much does a $1 million dollar annuity pay per month? ›
That comes to about $5,167 per month. Waiting to take payments could increase the amount you receive every month from a $1 million annuity. For instance, if you sign a contract when you are 60 years old and begin payments five years later, “your annual payout will be approximately $90,000 at age 65,” Coffman says.
Why take annuity instead of lump sum? ›
A lump sum allows you to collect all of your money at one time. On the other hand, an annuity is a series of steady payments that are made at equal intervals over time. These time periods could be weekly, monthly or annually. An annuity allows you to regularly collect part of your money over a pre-specified time frame.
What is the best age to take an annuity? ›
Investing in an income annuity should be considered as part of an overall strategy that includes growth assets that can help offset inflation throughout your lifetime. Most financial advisors will tell you that the best age for starting an income annuity is between 70 and 75, which allows for the maximum payout.
What are the disadvantages of taking lump sum pension? ›
What Are the Disadvantages of Taking a Lump Sum on Your Pension? Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. With life expectancies rising, many retirees face the increasing likelihood that they may outlive their savings, especially if they spend it.
Is it wise to cash out an annuity? ›
The literal costs of cashing out an annuity are clear: surrender charges, penalties and taxes can seriously add up. But you should think about the implied costs, too. Giving up an annuity (or two or three) means cutting off a reliable future income stream.
Should you take a one time lump sum or annuity payment. Should you spread the payment out over the course of many years?