Lump Sum Vs Annuity Facts
Protecting your money in today's world may not always be easy. However, as long as you understand the rules between a lump sum versus an annuity, it doesn't need to be scary. Research suggests that over half of the nation will likely come face to face with the decision of choosing which one or the other. Your ultimate decision comes down to a few important factors, including your current income, age, cost, faith in the system, and exit plan. Let's discuss each of these in detail.
An annuity is set up to seem like the safer bet, and under certain circumstances it might be. For instance, if you need the income from a pension to make ends meet for the next several years, it may be a decent option. The only unfortunate truth is that your annuity will lose its buying power over the next couple decades, which can spell trouble.
We don't need a crystal ball to predict that in the next 20 years a 2-percent annuity rate will lose approximately 33 percent of its buying power. This means that if you are just barely making it now, you will have to plan for having even less funds to work with in the future. If you have other means to support yourself over the next several years (job, etc.), a better option is to take the lump sum and roll it over into an IRA or other growing investment. Under most every circumstance you have a better chance of creating a big nest egg if you take your money as a lump sum. However, there is also another factor to consider - your age.
It takes time to compound a lump sum, so a lot of your plan will depend on when you start. Late bloomers may want to take a lump sum and invest a bit more aggressively, since you will be looking to build a nest egg as quickly as possible. Early risers may feel more comfortable taking an annuity that will guarantee a lifetime of income. The only thing to remember, is that its buying power will dwindle, so you may need to invest a portion of each payment to allow it to last a lifetime.
There is more options available to you than you may realize when choosing a payment plan. In fact, you also have the opportunity to take a lump sum, and purchase a commercial annuity from a different provider at a later date. Why would you want to do that? Because not all providers charge the same for their services. Your annuity will factor in the cost of managing your account, and will automatically subtract that cost from your earnings. In certain circumstances, it may pay to take your lump sum and sell it to another qualified provider who offers more competitive rates for their services. Try evaluating by using our settlement value calculator to see if it's in your best interest.
Faith in the System
The Pension Benefit Guaranty Corporation (PBGC) is a federal agency whose job is to protect pension participants. In the event of an annuity provider losing their ability to continue paying, they will step in and attempt to make things right. The problem is, this kind of protection is not unlimited. This is why it is always a good idea to check the credit rating of any company who will be handling your annuity or pension. It's your money after all. The simple fact of an annuity is that you are trading an asset for a promise. A promise to get a certain amount of money every month for the remainder of your agreement. Once you give that up, you lose the ability to control that asset, as well as the option to use it as a means to generate income. Some people may tell you that taking a lump sum is risky, but it is not a risk that you have to take on alone. There are a lot of professionals who are very good at managing the performance of your investments, so any risk can be minimized. Understanding the risks and rewards as well as the advantages of selling a settlement are all part of your personal due diligence before making a decision.
Your family is always a factor when deciding between an annuity or lump sum. Occasionally an annuity can be transfered to a spouse, and other times it will cease when you pass on. In cases where it will cease, a lump sum may provide additional resources for your family, and give them more options. The plain truth is, you will sleep more soundly at night knowing your loved ones are in good hands.
Special Considerations (lottery lump sum, etc.)
We have spoke to a lot of experts on the subject of lottery winnings and large pensions. When it comes to the choice between lump sum or annuity, a lump sum can net you more return in almost every case where a reasonable return is expected. And by reasonable, even two percent can net you a greater return; seven or eight percent has the potential to double your earnings.
There are no shortage of media stories that highlight the poor choice of someone who accepted a lump sum, and then spent it over the course of several years. These kind of stories push people away from a lump sum, because they fear following the same path. If you are really concerned, we'd like you to ask you how serious you are about enjoying the same quality of life you do now, or more importantly, if you would like to improve on it?
The only way to allow your money to work for you, is to take control of it as an asset. The best way of doing this is to collect your lump sum and then invest it in a way that will be most beneficial for you and your family. If you have more questions about these methods, please give us a call.