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A lump sum is essentially the opposite of an annuity. An annuity is a fixed sum of money that a recipient receives in increments on a regular basis, a lump sum is just a single, one-time payment. While receiving a lump sum payment instead of an annuity is attractive to some, it’s important to understand more about it before agreeing to it.
When is a Lump Sum an Option?
Lump sum payments aren’t always an option, but they usually are when it comes to retirement accounts. Retirees have the option of taking their pension as an annuity or receiving all the money at once as a lump sum.
Taking the lump sum for a pension payout comes with some benefits. Retirees don’t have to worry about losing out on any money for any reason. If the company shuts its doors and goes bankrupt, the retiree still has his or her money.
Retirees also gain control of their investments by taking a lump sum payment. They can roll the money into an IRA and enjoy annual growths. This also lets retirees avoid paying unnecessary taxes on their retirement accounts.
Of course, taking a lump sum in this case can be dangerous. The recipient could end up losing everything due to poor investment choices or poor spending habits.
Lottery winners also have the option between receiving their payout as a lump sum payment. This comes with a serious drawback though. People who take a lump sum payout receive significantly less than they would otherwise. The prize money is reduced for the lump sum payout because it is taxed significantly as a lump sum.
Alternatives to Lump Sum Payouts
Those who prefer monthly payments can go with the annuity option as an alternative to lump sums. As mentioned, this spaces out the overall payout over numerous fixed, habitual payments.
Many people like this because they can count on a check coming in every month. They don’t have to worry about bad investments wreaking havoc on their retirement income, and they don’t need to worry about blowing the money away at once. The check continues to come as long as the payment company remains solvent.
When pension holders take an annuity, they do lose control over the money. Most companies don’t adjust payments for inflation. If someone receives the annuity for years and years, the money might be worth less and less. It loses some spending power, and there is a no opportunity to invest the money with the market.
Lottery winners can also choose to take annuity payments. Lottery winners receive more of the prize money, but they get it on a monthly or yearly basis instead of all at once. It is ample money to live on in most cases, although they won’t have as much money to invest all at once.
Which is the Right Choice?
Choosing between a lump sum payment and an annuity comes down to what people want to do with the money. If they want steady payments, an annuity is the right option. However, if they want to make big investments and get full control of their cash early, a lump sum payment might be the right choice.
Author: Jeff Gitlen