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’ll receive your money. Will you opt for an annuity or the lump sum payment? About a third of private sector workers eventually grapple with this decision.
First, let’s define these 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 one-time payment of all the money owed to you, minus taxes and fees.
So which option should you take? Let’s look at the pros and cons.
Pros and Cons of a Lump Sum
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.
On the pro side, a lump sum payment could help you pay down high interest rate debt quickly, or make a major purchase in cash. Also, if you’re a savvy, disciplined investor, you could see great returns on your lump sum, putting you ahead of the game when compared with taking an annuity.
On the cons side, taking a lump sum payment comes with some risks. You might, for instance, spend too much money or live longer than expected. Both of these scenarios see you running out of money before the end of your life, a situation no one wants to wind up in. Another problem is the possibility of losing wealth in an unpredictable market.
If you’re a 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 lump sum payment for several more years than men do.
Pros and Cons of an Annuity
An annuity, for one thing, gives you a consistent annual or monthly payment that won’t shift with market turbulence. This helps you budget, and keeps you from withdrawing too much money from your retirement fund and eventually running out of cash.
On the other hand, an annuity doesn’t give you the flexibility to pay off debt, make a major cash purchase, or invest your money for potentially bigger returns.
Which is Best for You?
With all this 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 April 3, 2013.