Congratulations! You just won the lottery. Now comes the difficult question of whether to accept your winnings in installments over a long period of time or to take a lump sum payment. This might seem like a ridiculous question to ponder since you have a greater likelihood of becoming president or dying from an asteroid hitting the earth than winning the lottery. However, you will likely have to answer this same crucial question when it comes time to retire.
You’ve spent years carefully tending your retirement fund and now it’s time to decide how you will receive your money. Will you opt for an annuity or the lump sum payment? First, let’s define the terms. An annuity is a series of fixed payments over time. These will come in the form of monthly or annual payments. You might receive an annuity for a certain number of years or for the remainder of your life. A lump sum payment, on the other hand, is a single onetime payment of all the money owed to you, minus taxes and fees.
So which option should you take? About one-third of private sector workers must grapple with this question. The majority of retirees, perhaps lured by the idea of getting a huge pile of cash, opt for the lump sum payment. However, this is not necessarily the best decision. Lump sums are calculated by looking at interest-rate statistics and considering how long you will likely live. This should theoretically result in an annuity and lump sum payment being roughly equal. However, this is not often the case for a number of reasons. Accepting and investing a lump sum payment has its risks. You might spend too much money. You might live longer than you expected. And of course, you might lose some of your wealth due to an unpredictable market.
If you are woman, accepting a lump sum payment is a particularly bad decision, unless it’s absolutely needed. The payments are calculated using actuarial tables that don’t distinguish between men and women. Since women tend to live longer than men, they have to stretch the same amount of money for several more years than men do.
Alternatively, an annuity offers a consistent payment that won’t shift with market turbulence. It also protects you from withdrawing too much money from your retirement fund. However, there are some situations where taking the lump sum payment makes a lot of sense. You might have high interest rate debt or long term interest on a purchase. A lump sum payment can help pay these down. Maybe you are a particularly savvy and disciplined investor who can make great returns investing the lump sum payment on your own.
With that being said, the key factor in this decision just might be your own personality. If you’re worried about blowing the lump sum payment, go with the safety and security of the annuity. If you know you can control spending impulses and invest smartly, perhaps go with the lump sum. The decision is yours, but it certainly helps to be honest with yourself about what type of person you are. How to receive your retirement payments, lottery winnings, inheritance, etc. is immensely important and irrevocable. You’re stuck with the results for the rest of your life, so you should certainly consult a financial planner or accountant before making any decisions.
Published or updated January 30, 2012.
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Lump sum. I can manage my own money and generate my own returns.