These days, a retirement lump sum isn’t as attractive as it used to be (when compared to an annuity payout). When you take a lump sum after you retire, you have to open an IRA, invest the money and create retirement income. That hasn’t been such an easy task over the last 10 years. As a result, the annuity payout alternative looks kind of juicy. How do you decide?
1. Be clear on your objective.
At retirement, your objective is to create retirement income over your lifetime. Period. That being the case, the question is, how should you invest the money to create the most retirement income over the longest period of time with the least risk.
2. Understand how the annuity payout really works.
When you select an annuity payout, you trade in your lump sum for a series of payments. Those payments will never go up or down. This can be a very good thing…or a very bad thing depending on your situation and what the future has in store for you.
The insurance company calculates how much money they’ll pay you over the period based on a few things. If the annuity is a “life annuity,” they try to figure out how long you’re going to live. They do this based on life expectancy tables.
Next, they look at how much money they make on your money when they invest it. If interest rates are low, they earn less. If the insurance company earns very little, the payout you receive will be low too.
3. Think about your appetite for risk.
I don’t know about you but the older I get, the less risk I want to take. You’re probably in the same boat with me. That’s why lots of people are more interested in the annuity payout and fewer interested in the lump sum these days. When you take the annuity payout, you transfer the risk to the insurance company.
Having said all this, the lump sum is still the best way to go for me. I say this for a few reasons:
a. Interest rates are low. I don’t want to get locked into a low payment for the rest of my life.
b. Inflation may be low now…but I would be foolish to think it’s never going to be a problem. The annuity payment doesn’t compensate me for inflation risk. Equity growth investing holds out the potential for growth.
c. Firm risk. I don’t want to put all my trust into a company that looks strong now…but may not be such a pillar of fidelity down the road. Been there…done that.
Bottom line? The best strategy is to take the lump sum now and invest it wisely for retirement income. Consider the annuity payment down the road when you are older and interest rates might be much higher.
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{ 1 comment… read it below or add one }
I don’t like Annuities period Here’s why:
A: You have no control over those funds anymore. You are at their whim.
B: You are at the mercy of their financial health for as long as you live. This is also a good reason why to have Defined Contributions and not Defined Benefits, as with Defined Benefits, you are at the mercy of the health of the employer for as long as you live.
C: Your payments don’t go up with inflation in many cases, and even if it does, it’s not without a high cost for it.
Your A and B kinda fits into my C.
As such, I will rather take the lump sum method with my set of financial and investment rules over annuities.