When you retire you have many decisions to make, and one may be whether to take your retirement income as a lump sum or an annuity payment over your lifetime. If you have that choice, it’s important to consider your options carefully. For most people it could be a mistake to take a lump sum instead of an annuity, at least according to a 2016 Harris Poll study of retirees. (For more, see An Overview of Annuities.)

Lump Sum or an Annuity?

The study, Paycheck or Pot of Gold, was commissioned by MetLife, one of the world’s largest life insurance companies and a provider of financial services. The Harris Poll study revealed that 21% of retirement plan participants who took a lump sum depleted it in 5.5 years on average. Of those who still had money left, 35% said they were worried about running out during their lifetime. Although more than 85% of those who took a lump sum said they were glad they made that choice, many had serious financial concerns about budgeting or regrets about making large purchases early in retirement. 

The Disadvantages of a Lump Sum

The biggest disadvantage of taking a lump sum at retirement has to do with risks. There are several, and each is worth considering.

  • Overspending – Having access to a large wad of cash sounds attractive, but it also invites overspending. An annuity check once a month does not have nearly the disadvantage a lump sum does in that regard.
  • Poor Investment Results - In order to generate income from a lump sum, you need to invest it wisely. That can be tricky, even for experienced money managers. You can pay someone to invest it, but that will cost you. Either way you risk running out of money.
  • Loss of Subsidies – Taking a lump sum can cause you to lose money in other ways besides investment results. Companies that subsidize early retirement to get workers to leave are not required to factor in that incentive for lump-sum offerings. This could result in annuity recipients getting up to 50% more than those who receive a lump sum, according to the Pension Rights Center.
  • Dementia – It’s not pleasant to think about, but as we age the risk of dementia, including Alzheimer’s, goes up. If you elect to take a lump sum and then become mentally impaired, you could mismanage your own funds or, worse yet, be taken advantage of by an unscrupulous individual.

Advantages of a Lump Sum

It isn’t all bad news. There are some potential advantages to taking a lump sum that can, in certain situations, outweigh the disadvantages.

  • Control – No doubt about it, if you take a lump sum, it’s all yours. You have complete control and, if you are a wise investor, may even be able to beat the return an annuity provides. In addition, if there is a balance at the end of your life, you can pass that along to your heirs. Some annuities stop when you or your spouse dies. 
  • Protection From Employer Instability – Annuities are guaranteed by your former employer. Those benefits could be reduced in the event your employer mismanages the pension fund. It’s worth noting that most pensions are protected – at least in part – by the Pension Benefit Guarantee Corporation.
  • Inflation Protection – With a lump sum you can withdraw funds in a way that offers some protection against inflation. Most annuities do not offer inflation protection in the form of a cost-of-living adjustment.
  • Tax Advantage – If you roll your lump sum into an individual retirement account or other tax-deferred plan, you will only be taxed on the money you take out – which could be none if you have sufficient income from Social Security or another pension. You will need to begin withdrawals at age 70½, thanks to the Internal Revenue Service’s rules for required minimum distributions. All of your annuity income is taxed when you receive it.
  • Life Expectancy – If you are especially ill or have a condition that significantly threatens your life expectancy, you may be better off taking the lump sum. If you are married and plan to take a spousal benefit, however, factor in your spouse's health as well.

The Bottom Line

Before making a final decision between an annuity and a lump sum, consider each of the factors mentioned above, including your health, your skills as an investor, other retirement income you may have, debt you may want to pay off (with a lump sum) and the tax consequences of your decision. Most people are better off with a lifetime annuity than with a one-time lump sum. In order for a lump sum to be the better option, you really need to be the exception, not the rule. No matter what you personally think, be sure to seek advice from a qualified financial planner to help you look at both options in detail before you decide. (For more, see Lump Sum Versus Regular Pension Payments.)

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