Taking a Lump Sum vs. Annuity from a Pension: Which One is Better?

You can choose to receive your pension as a single lump sum or as regular annuity payments over time. A lump sum gives you capital to make large purchases or invest, but your money can run out. An annuity gives you a steady stream of income for the rest of your life, but provides less flexibility.

So which should you choose? It’s a critical decision, and it’s irrevocable, so consider wisely. This Could be the most important decision you make for your retirement plan.

The best choice for you depends on your circumstances. If you want flexibility and have plans to grow a large amount of cash, consider the lump sum. But if you prefer having more financial certainty in your later years, the annuity may be the best route.

In this article, we explain both options, how they work, and the benefits and drawbacks of each.

Note: In this article, we do not discuss lottery annuities; we’re focused exclusively on payout options for your pension. Check out our article lump sum vs. annuity lottery payouts for more about lottery annuity rules and payment options.

Pros and Cons of Taking a Lump Sum from a Pension

One option for your pension payout is to receive your entire pension as a single lump sum payment. The lump sum option means that your pension administrator would send you a one-time check. You get to decide what to do with that cash: save it, spend it, invest it, buy an annuity contract — the choice is yours.

Advantages of the lump sum payout include:

• Flexibility. You can choose how to use your pension benefit. This can be especially useful if you have surprise expenses or need to pay off debt.
• Investments. Some retirees invest their pensions in stocks, mutual funds, or other investment options. Investment returns can provide regular retirement income (but you could lose money investing too).
• Beneficiaries. You can name a beneficiary to receive your money after you're gone. This lets you more flexibly engage in legacy planning.

But there are some disadvantages too. The cons of the lump sum option include:

• Management. Lump sum distribution payouts from pensions are often the largest single check a person gets in their life. If you’re not sure how to manage it, you could end up wasting it, or having its value erode from inflation.
• Uncertainty. Will your money last? What happens if you spend your entire nest egg before you die? With the lump sum option, that’s a real possibility.
• Taxes. You’ll pay ordinary income tax on the lump sum. And if it’s a big sum, you might be pushed into a higher income tax bracket, with a higher income tax rate. Note that you can avoid paying these taxes immediately by rolling over your lump sum into an annuity or an IRA.

Pros and Cons of Annuitizing a Pension

So how does that compare to the annuity payout option?

With the annuity option, you choose to receive your pension in regular payments for the rest of your life. You can usually choose between receiving your pension payments on an annual, quarterly, or monthly basis. You will usually receive lifetime payments, which means that the income will last you for the rest of your life.

This option has some enormous benefits:

• Financial certainty. You know you will always have your pension payments to supplement your social security check and other retirement income. That offers peace of mind for many people, knowing that they will always have some income to pay the bills.
• Legacy planning. You may be able to name a beneficiary to continue to receive your pension income after you die. To do this, you would have to choose a survivor benefit or a term-certain option. (Note that not all pensions offer these options).

But there are also some disadvantages:

• Lack of flexibility. Once you decide to receive monthly annuity payments, that’s it. You won’t be able to access that money until it’s paid to you from the pension plan. If something happens and you need quick cash, you’ll have to get it from somewhere else.
• Legacy planning. Some pension plans may not offer death benefits. If that’s the case, the monthly payments will stop when you die and will not pay your families or beneficiaries. You may even die before collecting all the money you’re owed.

Which is the Right Option for You?

So how do you choose? Think about your situation and what matters most to you. Here are some of the factors you may wish to consider.

Life Expectancy

How long do you think you’ll live? If you are healthy and think you’ll live longer than the average life expectancy (which is currently 79-years-old in the US), the annuity may be preferable. It can offer you a steady income and ensure you don’t run out of your retirement savings early. Otherwise, the lump sum payment option may be ideal: that way, you can ensure you have access to all the money you are entitled to.

Of course, no one really knows how long they’ll be around, but think about your health. If you’re very healthy and your parents lived to be 90, you may want to plan for a long retirement. If you have poor health, it may be better to take the lump sum option and have the cash available for any surprise medical expenses.

Return on Investment

Ideally, your money will work for you and create earnings. It can do that in a few ways. One is by making investments such as buying and selling assets or securities on the stock market. Another is by generating interest.

Pension annuity payments generate little interest and you are likewise unable to invest that money until it’s distributed to you on the payment schedule you have chosen.

The lump sum option can generate a better return on investment. If you’re a confident investor, you could use that lump sum to generate investment income. Even if you’re not, you could choose a very low-risk place to put your money that can still earn some interest.

For example, you could buy a fixed annuity. Fixed annuities are very safe, and offer a guaranteed minimum interest rate so you can be sure that your money will grow (as long as you leave it in the annuity account for the specified term). Fixed annuities rates are usually fairly high compared to other low-risk investments.

Fixed annuities are just one way you can safely grow your pension lump sum without adding too much risk to your portfolio.

Retirement Income

Most Americans are worried about how they’ll pay their bills in retirement. If that’s a real concern for you too, the annuity payout option may be especially attractive. It helps you feel confident that at least some pension money will be coming in each month. It gives you enough financial stability that you can be confident you’ll be able to put bread on the table.

If you’re not sure which pension payout option is best for you, consider talking to a financial advisor. They can help answer your questions and give advice based on your specific financial circumstances and goals.

What if You Don’t Have a Pension?

If you’ve contributed to a pension fund over your working life and are about to retire, congratulations.Those contributions are about to come back to you as income. After reading this article, you’re empowered with information about your pension payment options.

If you choose the lump sum, you’ll have flexibility, but you’ll sacrifice certainty. If you choose the annuity payment option, you’ll give yourself some certainty, but you’re limited in your access to the funds. The right decision for you depends on your needs and goals. If you’re unsure, talk it over with a financial adviser.

What if you don’t have a pension? Well, you’re in luck. Canvas Annuity offers low-risk fixed annuities for purchase. Like a pension, these offer many benefits for retirees: a guaranteed income in retirement, tax benefits, and a guaranteed minimum interest crediting rate.

Buying an annuity contract can offer you a guaranteed retirement income just like a pension can and give you that same certainty and feelings of security.

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