Should You Take Your Pension as a Lump Sum Vs. An Annuity?

We recently assisted a young retiree in deciding between taking her pension as a lump sum or an annuity. Given the size of her pension, it was important to thoroughly analyze each option without jumping to conclusions.

We hope this case study will help you make informed decisions if you ever find yourself needing to determine what to do with your pension. Similarly, if you're thinking about using some of your investment money to buy an annuity, the same ideas apply.

Client profile and personal circumstances

• Single woman
• Early 60s
• History of longevity in the family
• Average risk tolerance
• Homeowner with a manageable mortgage
• Modest lifestyle
• Other retirement resources are available

Analysis and projections

We prepared multiple retirement scenarios to evaluate how each decision would impact our client in the long run, up to age 95. 

We took into consideration the available resources, including Social Security income.

The projections included conservative rates of return: 6% and 7% in the long run.

Each scenario was adjusted for taxes and inflation to ensure the results were comparable to the client’s current budget.

Projection results: lump sum vs annuity

In this specific case, there was not a significant difference in the total projected retirement income when we used a 6% rate of return.

However, the difference between the two options at a 7% rate of return turned out to be $1,400 per month or $16,800 per year in favor of a lump sum approach.

To confirm, the idea was to rollover the pension benefit into the client’s IRA. A lump sum distribution into a regular bank or investment account would result in a significant tax liability.

Client discussion: pros and cons of each approach  

Even though mathematically it was better for the client to take the pension as a lump sum, we wanted to ensure we discussed each approach in more detail. This decision is irrevocable, and you want to be certain that you are making the right decision for your personal circumstances!

One of the biggest advantages of the annuity approach is the fact that you will receive a fixed amount for the rest of your life regardless of the stock market fluctuations. This can help cover a portion of your expenses, specifically those that don’t fluctuate much each year (e.g., utilities, food, etc.). This annuity approach simplifies your overall finances.

One of the major disadvantages of the annuity approach is the loss of flexibility. With the lump sum approach, you can always increase or reduce how much you withdraw from your Rollover IRA account.

You can also adjust your distributions based on your tax situation each year. This is important if you ever consider strategies such as Roth conversions.

The lump sum funds can be invested in any manner that is appropriate based on your risk tolerance, personal preferences, and growth needs.

Finally, with the lump sum approach, there is a possibility for your beneficiary to inherit some of the funds if not used throughout your retirement.

Outcome and recommendation

The client decided to take the pension as a lump sum.

The funds were rolled over into her IRA and invested according to her overall investment policy.

We believe this was the most optimal decision based on the circumstances of this specific client.

It is worth mentioning that your situation and ultimate decision of lump sum vs. annuity can be very different! Please do your own due diligence or feel free to reach out to us if you need any assistance.