Investing A Lump Sum Vs Annuity For Retirement

Ensuring a comfortable retirement is a priority for a lot of people.

Investing A Lump Sum Vs Annuity For Retirement

When you reach the age when you are ready to retire you want to have a steady and reliable source of money so you can continue to live a full and happy life and keep yourself comfortable. But what is the best way to do this? 

Most pension plans come with an option for a lump sum or annuity. But what is the difference between the two options? Which options make the most financial sense?

If you want to know more about pension options and retirement then you have come to the right place. We have put together this guide to tell you everything you need to know about lump sums vs annuity. Keep reading to find out more.

What Is The Difference Between A Lump Sum And Annuity? 

When your pension plan kicks in you will usually have two options – a lump sum or annuity payments. 

Annuity payments is when your retirement fund is paid to you periodically – either weekly, monthly, quarterly or annually. This gives you a steady stream of income. A lump sum is when your entire retirement fund is paid to you up front and you need to manage it yourself. 

The exact terms and conditions of each type of payment will vary depending on your retirement plan (Find out What Is A NonQualified Retirement Plan?). Some plans will continue to pay annuity to your spouse or children after your death, whereas others will not.

Some plans will penalize you for taking the lump sum by reducing the overall amount in order to encourage you to choose annuity. Make sure you understand your pension plan before you make your decision. 

Different Types Of Annuity Payments 

Here are some of the different types of annuity payments you could have with your pension plan: 

  • Single Life Payment – This offers you the highest monthly payments, but when you die all payments stop 
  • Single Life Payment Term Certain – This offers you a slightly lower monthly amount, but the payments will continue to your spouse or beneficiaries for a specified period of time after your death 
  • 50% Joint And Survivor – Your monthly payment is lower, but after your death your surviving spouse will continue to receive a monthly payment of 50% of your annuity payments.
  • 100% Joint And Survivor – This option gives you the lowest monthly payment, but after your death your surviving spouse will continue to receive full annuity payments for the rest of their life. 

Is A Lump Sum Better Than Annuity Payments? 

Is it better to receive your money in regular payments, or as one lump sum? This is a personal choice and it depends on several things. 

Lifespan

It might seem morbid, but you need to take into account your health and your life expectancy. If you only expect to live for 5 to 10 years after retirement then it is best to take your money as a lump sum.

It will be easy to make it last for that long, and it gives you more control over your finances. Depending on the type of annuity you have with your plan, you could end up not using a large chunk of your pension money.

(If you have annuity payments that go to your spouse or children after your death then this is not as much of a concern). 

Inflation 

The rate of inflation is increasing much faster than it ever was before, which is causing a big issue for pensions. The money you set aside all those years ago is worth a lot less now.

If you take your pension in annuity payments, each year your payments will be worth less and less. What started out as enough to live on could leave you scraping by and counting the pennies.

If you take a lump sum, you can invest your money and continue to make more, helping you to keep up with rising inflation rates. 

Investment 

One of the benefits of taking your pension as a lump sum is that it gives you the freedom to invest the money and make more. This comes with an element of risk, and you shouldn’t invest all of your money in case it goes wrong.

However, you can seek financial advice for low risk investments that will keep making you money and helping you to live a more comfortable and sustainable retirement. 

Spending Habits 

If you have a history of poor financial decisions, impulsive or excessive spending, bad credit and unrealistic budgeting, a lump sum is not the right decision for you.

If you take a lump sum you will need to make that money last which involves careful planning and sensible decision making. If you choose annuity payments you will not be able to spend all the money at once and it will be given to you gradually.

This makes it less likely that you will spend the money irresponsibly. 

Which Should You Choose? 

If you are a cautious person who would rather play it safe then it may be best to go with annuity payments. There is no risk of the money running out before you die and don’t need to try and plan out the payments yourself.

Over time, you might find that the payments don’t stretch as far as they used to due to inflation, but it is still a safe option. 

If you are good with money and you know a thing or two about investments then taking a lump sum will probably work out better for you. This allows you to turn your lump sum into even more money, giving you a very comfortable retirement.

You can also pay off any debts which allows you to have a debt free retirement. You will need to plan your finances carefully to ensure that your money doesn’t run out, but you can seek financial advice to help with this. 

Summary 

Having a pension plan will make your retirement much more comfortable. Choosing between a lump sum and annuity payments is a personal and important decision but if you consider the points raised above you should come to the right choice.

Andre Flowers
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