Brian from Bethesda, MD:
My company Pension is being terminated and I need to make a decision about how to receive my benefit. Should I choose to take the lump sum or the annuity?
That’s a great question, and one that we hear frequently. You may actually have several variations of Lump Sum and Annuity choices. Let’s review the most common choices and the pros and cons of each.
Take a TAXABLE distribution
- Benefits – Get all of your cash now
- Detriments – Accelerates tax consequences. Could push current period income into higher income brackets. Could potentially create penalties, if under age 59 ½. Investments no longer grow tax deferred.
Lump Sum 401k rollover
- Benefits – Can invest in a basket of mutual funds now with flexibility to roll to an IRA or Annuity at age 59 ½ or retirement. Investments generally fluctuate with relative stock and bond markets of commensurate risk level.
- Detriments – Must manage yourself inside the 401k. Investments generally fluctuate in value and may depreciate.
Lump Sum IRA rollover
- Benefits – Can invest in any investment instrument available at your custodian (10,000+ instruments). This generally provides ability to select the most competitive instruments. Investments generally fluctuate with relative stock and bond markets of commensurate risk level. Retain the ability to hire a professional Investment Advisor if desired.
- Detriments – Investments fluctuate in value and may depreciate.
Immediate Annuity (Employer or Private carrier)
- Benefits – Guaranteed fixed monthly income beginning now
- Detriments – Accelerates some tax consequences, as monthly income is taxable and begins now. Locks in today’s relatively low interest rate environment. Locks in a full life expectancy (a future life shortening illness would truncate the benefit of an annuity)
Deferred Annuity (Employer or Private carrier)
- Benefits – Guaranteed fixed monthly income beginning in the future (generally retirement)
- Detriments – Locks in today’s relatively low interest rate environment. Locks in a full life expectancy (a future life shortening illness would truncate the benefit of an annuity)
We find that most people choose the Lump Sum and roll it into an IRA, mainly for the flexibility of current investment and the ability to purchase an annuity in the future should they need one in retirement (and are still in excellent health). The primary exceptions to this are the individual that intends to work for their company past the age of 70 or is the subject of creditors (being sued), who often transfers into their 401k, if allowed. The other exception might be someone who is retiring NOW, who is in excellent health (with longevity in their heredity), and thus selects the immediate fixed rate annuity. We NEVER see anyone taking the TAXABLE distribution, because of the onerous tax consequences.
Since life expectancy is such a driver of the benefit of an annuity vs. a lump sum, you may want to examine your own life expectancy on a site like www.livingto100.com, which factors in your heredity, health, and habits.
We hope that was helpful. To view our entire collection of Asked & Answered articles, please click on our blog!
The Friedenthal Financial Team
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If you know someone who would like to discuss their investment needs with us, we certainly appreciate the introduction.