Are you wondering how to confidently choose a pension payout option? If you are nearing retirement and are entitled to receive a government or corporate pension, you may be faced with the difficult task of deciding whether you want to receive your retirement benefits in a lump sum amount or monthly annuity payments over your lifetime.
Oftentimes, the decision between these options can come down to which choice will provide retirees with the greatest income, though there are some additional considerations to keep in mind. While one option provides lifetime guaranteed payments and is the more traditional choice, the other option can give you more control over your money and may even help you amass greater wealth for yourself and your family.
Choosing between a lump sum or monthly annuity is a large and irrevocable decision that has major implications throughout the rest of your lifetime and for your beneficiaries. So, let’s dig into how each option differs, when it makes more sense to choose one over the other, and how you can make the right choice for you and your loved ones.
Monthly Annuity Payments
If you receive your pension through monthly annuity payments, you are guaranteed a fixed monthly income that will last throughout your lifetime—no matter how long you live. Plus, you can even guarantee lifetime spousal benefits. If you and your spouse make this choice, you will receive a reduced monthly payout, but it could be a better option for couples over the long run.
While some prefer the lump-sum payment for flexibility, many still opt for the traditional monthly pension payments. Living off a rigid and fixed income may keep retirees on budget and prevent overspending, which could be more tempting and easier to do with a lump-sum payout. Plus, some pensions may even offer cost of living adjustments based on inflation.
Overall, receiving monthly annuity pension payments is safer and more stable than the lump-sum route. However, your earnings potential is limited and will require diligent planning and budgeting should an adverse event require an outsized payment—like medical bills or house repairs.
In addition, you are depending on the financial solvency of the pension administrator, and your payments could cease should they file for bankruptcy. However, defined-benefit plans are protected by the Pension Benefit Guaranty Corporation up to a certain amount, which is about $74,455 annually for a 65-year-old retiree in 2022.
Spousal protection through insurance
If you choose to receive monthly annuity pension payments, there are some additional options you have to increase your benefits, especially for surviving spouses and other beneficiaries.
Selecting the single-life annuity plan will make your monthly benefits higher, though your spouse will forfeit receiving any payments. In this scenario, you can purchase an insurance policy outside your pension plan and pay its monthly premiums. Upon your passing, the surviving spouse or children will receive a lump-sum payment.
You’ll want to select the insurance plan carefully, as you don’t want to let the policy expire before it’s required or cause a significant income gap if it’s miscalculated. So, consulting with a financial advisor during this process could benefit.
Opting for a lump-sum distribution payment means you will receive a one-time payment in the amount of your pension from its administrator upon retirement. With this option, you will receive a large amount of money all at once that you can choose to manage in several ways. Whether you decide to spend or invest this lump-sum amount is up to you, but the bottom line is that you have increased flexibility in deciding what to do with this money.
If you decide to invest a portion of the funds, you can explore a few different avenues to grow your money and keep your retirement well-funded. You can still invest in funds that will provide you with a regular income while having the ability to explore the upside potential from other investments that you couldn’t do with monthly annuity payments.
Thus, several benefits can come from choosing to receive a lump-sum payment. Many favor the flexibility and control they can gain from this option, as living off of a fixed income for a decades-long retirement can be limiting. Plus, consulting with a financial advisor can help you make smart choices with the money and aim to maximize your income during retirement.
Even still, there are some additional levels of risk involved with the lump-sum selection, as you are not entitled to guaranteed monthly payments as with the other option. With life expectancies in the US rising, there’s always a possibility of running out of money during retirement if you aren’t planning diligently and investing your money properly.
How is the lump-sum payment calculated?
The pension administrator will calculate how much your lump-sum payment will be if this is the route you choose to take. Technically speaking, there shouldn’t be a difference between the amount you will receive taking this option and receiving monthly annuity payments, as the administrator will use the average life expectancy and the amount of the monthly annuity payments to provide you with the lump-sum amount.
However, if you live longer than average, you may benefit financially from taking the monthly annuity payments. On the other hand, if you find yourself in the opposite scenario, the lump-sum option could provide you with greater financial gain.
Differences Between Lump-Sum and Monthly Annuity Payments
There are some key differences between lump-sum and monthly annuity payments for pensions that could help you determine which is better for you. At the end of the day, whether you choose lump-sum or monthly annuity payments will be a personal decision, and consulting with a financial advisor can help you make the decision that’s right for you based on your financial health and individual situation.
There are large differences between lump-sum or monthly annuity payments regarding how they are taxed. Firstly, monthly pension payments are taxable, so you will continue to pay income taxes on them throughout your retirement.
On the other hand, if you roll over your lump-sum pension payment into an IRA, you have more flexibility and control when it comes to when you face the tax liabilities on that money. Of course, you will be subject to taking the required minimum distributions once you turn 72, having your money in an IRA will allow you to have more of a tax strategy on your retirement income.
Family & beneficiaries
If you want to leave something behind to your family after your death, it’s important to understand that choosing between lump-sum or monthly annuity payments could impact your ability to do so.
If you choose to receive a lump-sum payment and invest it privately, you can name beneficiaries to your money so they can inherit what is left over once you’re gone. On the other hand, most pension payments will cease once you and your spouse have both passed, so you can’t name beneficiaries to this money.
You will want to consider how your medical coverage could change depending on whether you choose to take the lump-sum or monthly annuity payments. Sometimes, company-sponsored medical insurance will end if you receive the lump-sum payment, but coverage will remain if you choose monthly annuities.
So, you may need to plan for other arrangements for your health insurance if you decide to take the lump-sum payment. Thus, considering the costs of Medicare supplements and other insurance policies, you’ll require during retirement should be a part of this decision.
How to Confidently Choose a Pension Payout Option?
It is not an easy choice to decide between these two options, and will likely take some meaningful discussion before making the final decision. Oftentimes, it will come down to the pension calculation, which workers can request from their pension administrator. The calculation will break out the payments and all available options, so workers can decide which route is better suited for them.
It’s also important to note that not all pension programs will offer a lump-sum payment option. So, when considering this decision, you’ll need to check with your administrator to find out the specific details about your program.
Plus, if you’re working with a financial advisor, they could get quotes from reputable insurance companies to determine which policy is best and help you discover alternate investment routes that can help fund your retirement and benefit your surviving loved ones once you are deceased. In addition, with the private pension route, insurance companies can sweeten the pot by adding additional benefits, such as an increased payout or a death benefit.
Bottom Line: Is a Lump-Sum or Monthly Annuity Better?
As you can see, there are certain instances where the lump sum payout wins. In other situations, the private pension option can provide more control over when the retiree gets income and, quite possibly, a higher guaranteed benefit.
If you want to learn more about how you can be better prepared for retirement and the subjects discussed here, join one of our upcoming webinars. We cover topics like how you can make smarter decisions with your money, maximizing your Social Security benefits, or managing your wealth in the post-COVID world.
Securities and advisory services offered through Independent Financial Group, LLC (IFG), a Registered Investment Adviser. Member FINRA/SIPC. Vaylark Financial Services and IFG are unaffiliated entities. Licensed to sell securities in the following states: CT Information provided is from sources believed to be reliable however, we cannot guarantee or represent that it is accurate or complete.
Opinions are those of the author and not necessarily those of Vaylark Financial Services or Independent Financial Group (IFG). IFG does not provide tax or legal services. Please discuss these matters with the appropriate professional.
Investing is subject to risk, including possible loss of principal. Determining which investments are appropriate for an individual investor will depend on your investment objectives, risk tolerance, and time horizon and should be discussed with your financial advisor before implementing any investment plan.