Should you take a lump sum now or an annuity check later?

Dear Liz: My former employer is offering the one-time opportunity to receive the value of my pension benefit as a lump-sum payment. The other option is to leave the money where it is and get a guaranteed monthly check from a single life annuity when I reach retirement age. I am 40 and single, and I have been investing regularly in a 401(k) since graduating from college. I have minimal debt aside from a car payment. When does it make financial sense to take a lump sum now instead of an annuity check later?

Answer: Theoretically, you often could do better taking a lump sum and investing it rather than waiting for a payoff in retirement. That assumes that you invest wisely, that the markets cooperate, that you don’t pay too much in investing expenses and that you don’t do anything foolish, like raid the funds early.

That’s assuming a lot. Another factor to consider is that the annuity is designed to continue until you die. It’s a kind of “longevity insurance” that can help you pay your bills if you live a long life.

Some financial advisors will encourage you to take the lump sum, since they may be paid more if you invest it with them. Consider consulting instead a fee-only financial planner who charges by the hour — in other words, someone who doesn’t have a dog in this particular fight. The planner can walk you through the math of comparing a lump sum to a later annuity and help you understand the consequences of both paths. This is a big enough decision that it’s worth paying a few hundred bucks to get some expert advice.

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  1. Other considerations apply to this issue. When taking a lump-sum, the amount is determined by what would otherwise have to be invested to pay an annuity that would be exhausted at the end of the retiree’s expected life-span, in an investment that pays a fixed interest rate equal to the current 30-year treasury bond.

    When I opted for a lump-sum at retirement in 2003, interest rates were quite low. This meant I receive a large payout. I used a trustee-to-trustee transfer of the funds into an IRA at Vanguard, which is a low-cost mutual fund. Sticking with a mixture of stock and bond funds that, combined, represented only a moderate risk and pursuing a strategy of rebalancing as often as monthly, my total investment has slowly grown. So far, I have taken out of my retirement investments less than the ordinary dividends and interest that they earn.

    The key is picking a ratio between stocks and bonds with which you are comfortable and then rebalancing at least quarterly if not monthly — and even more often if there are dramatic changes in the actual ratio versus the selected ratio. After all “rebalancing” is merely another way to say “buy low and sell high”.

    For details on my strategy for investing for retirement, see the cited Web page. No, I am not a professional investment advisor; and I do not charge for my advice or otherwise profit from giving advice.

    • Thanks for your comment, David. I recommend that anyone facing this decision discuss it first with a fee-only financial planner who can offer customized advice. This is an important decision and a mistake could affect the rest of your retirement.