It is a commonly held belief that when confronted by a situation in which you have to choose between a lump sum and scheduled payments, you’re better off selecting the long-term payment plan since it will result in more money over time. Despite this general knowledge, most people end up taking the lump sum, which is more money right now (albeit less in the long run). But when it comes to accepting a lump sum or opting for pension payments when you retire, is one path preferable to the other? How do you know which one to choose? In truth, there are a few things you need to know about the potential benefits and drawbacks of each before you can make an informed decision. And the one that’s right for you will depend largely on your personal situation.
The first thing you need to understand is that pensions are generally a guaranteed life annuity. What this means is that they will begin to pay at the point of retirement and continue paying out until the time of your death, after which any remaining funds will be passed on to a named beneficiary (usually a spouse) or they will be forfeit. So regardless of the amount of money accumulated in the pension, the sum you receive will depend largely on your longevity. That said, when a lump sum is offered in exchange for scheduled payments, it is nearly always going to be of lesser value than the total of the annuity fund. Still, there are several reasons to carefully consider both options.
Suppose you are dealing with a chronic illness that is likely to cut your life short. In this case you may want to take the lump sum in order to pay medical bills and perhaps even take a few trips or have some fun in the meantime. After all, you can’t take it with you. Alternately, you might want to use some of the money to set up trust funds for a spouse, children, or grandchildren, or make donations to charity as a way to ensure that your pension funds aren’t lost when you pass away. Although you’ll take a slightly smaller amount of money than you might have had, it could end up paying off for you considering that your loved ones would lose out in the event of your early passing.
On the other hand, more and more adults find themselves reaching the age of retirement these days in excellent health and with the prospect of several more decades of life to enjoy. With a long road ahead, you may be keen to have monthly or annual payouts to look forward to as a way to continue living the lifestyle to which you’ve become accustomed. You might not want to lose money on both the lump sum payment and related taxation, especially considering that a massive payout could lead to owing a larger percentage to the government. Or you may not be confident in your abilities to wisely manage such a large chunk of change. In truth, you might want to learn more about your options before you make a decision. By considering the pros and cons and applying them to your own situation you should be able to determine which type of payment best suits your needs.