Lump Sum or Annuity? That is the Question.

lump sum or annuityThe old defined benefit pension plan where your employer has made a pledge to contribute to your retirement in exchange for your hard work and loyalty is going the way of the pay phone.  Or probably a better analogy is the land line.

There are still a significant number of people who are eligible for pension benefits, but most are at or nearing retirement.  Choosing whether to take the lump sum or an annuity option is difficult and often requires detailed analysis by a professional to make an informed decision.

5 Tips to Answer: Lump Sum or Annuity?

While it is important to run the calculations to compare the different choices, as an adviser it is just as important to have a thorough understanding of the client’s unique situation.

There are many factors that need to be considered in order to provide a recommendation that will fit the client’s needs.


  • What is the client’s risk tolerance for using a portfolio strategy with allocations to stocks?  Stocks provide the best opportunity for higher returns over the long term; however, some people cannot tolerate the volatility inherent in stock investments.  Choosing the annuity will provide peace of mind even though going with the lump sum and investing often produces higher odds of a better outcome.


  • What about inflation risk?  Most pension plans do not have a cost of living adjustment.  Once the annuity benefits start, they remain fixed while the cost of food and gas continues to go up.  For those with a low risk tolerance, taking the annuity can still make sense in many cases as the monthly pension income can often provide the cash flow support to defer Social Security, which does have cost of living adjustments.


  • What other assets and resources are available?  We already mentioned Social Security, but if there are other retirement savings like a 401k or Roth IRAs there is more flexibility for either taking lump sum or going with the annuity.  For the risk averse, consistent monthly income from the annuity can calm fears enough to put a portfolio strategy involving stocks in place within the other assets.


  • What are the considerations for the spouse?  The annuity options will include a choice of how much the surviving spouse would continue to receive in the event that the pensioner predeceases.  Part of the analysis may include weighing an option to add life insurance coverage on the pensioner vs. taking the reduced monthly amount while both are living.  A discussion of their respective health situations would certainly be necessary.


  • What is the financial condition of the pension plan?  The Pension Benefit Guarantee Corporation provides insurance against plan default.  However once the PBGC takes over a plan there are some restrictions that may negatively impact the client’s financial strength.  Taking the lump sum removes this risk.


These are a few examples of why it can be critical to seek professional guidance before deciding on your pension benefits.

As financial planners we have helped many clients go through this process.  If you have a pending decision on your pension or would like to find out more about our planning services please contact our office for more information.


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