SmartAsset and Yahoo Finance LLC may earn commission or revenue from links in the content below.
Deciding between a $500,000 lump sum or $3,500 monthly annuity payments for your retirement is not easy and involves weighing several personal factors. You need to consider how long you might live, which affects the total amount of money you receive from monthly payments, in addition to your retirement age, to see how long your money should last. Investment potential is another aspect; If you take the lump sum, what kind of return can you expect? Annuity policies can also have different features, such as inflation protection and beneficiary provisions, which can also play a role in the value of both options. Also consider how comfortable you feel managing a large sum of money; not everyone is up for the task of investing. Your current financial obligations also play a role.
Here are some factors to consider. You can also use this free tool to match with up to three fiduciary financial advisors to help you weigh your options.
Suppose you are making a choice between the pension payout options. By taking out your pension in one go, you can pay off debts, set aside an inheritance and potentially generate higher returns through effective investment decisions. Taking settlement in the form of monthly payments also offers benefits, including greater security through the pension guarantee and, depending on the details of the pension, inflation protection or survivor benefits that could potentially help support a partner after you are gone.
Here are some important factors to consider:
-
Size of the lump sum
-
Size of monthly payments
-
When the lump sum will be available
-
Life expectancy
-
Return on investment.
-
Risks, including that the lump sum payment will run out or the monthly payment will not support your lifestyle
Depending on individual circumstances, some other factors may also be important. For example, if you have a lot of debt, a lump sum can be used to pay off those debts, freeing up cash flow to support your lifestyle. Or, if the pension includes a survivor benefit for your spouse, that could be important if your spouse needs these benefits to maintain his/her lifestyle after you are gone. Also, someone with low financial literacy or a tendency to mismanage large sums of money may be better off accepting the monthly payments. If you need help navigating your policies or potential investment options, consider speaking to a financial advisor.
When choosing between a lump sum of $500,000 and monthly payments of $3,500, the relative value of each option must be estimated. For this example, assume the pension recipient is a 60-year-old man who, according to Social Security estimates, has a life expectancy of another 20 years. If this person retires at age 65 and collects $3,500 per month for the next 15 years, the value of the monthly payment option becomes 180 months times $3,500, or $630,000.
Now consider the flat-rate option. If this 60-year-old man were to receive the $500,000 lump sum immediately, it could be invested for the remaining twenty years of his life. Using a lump sum versus annuity calculator, the lump sum option would only need to generate a modest annual investment return of 1.9% to match the relative value of the monthly payment option. This indicates that in this case the lump sum option is preferable, although this is an oversimplified calculation.
For example, this example also doesn’t take inflation into account, and that probably matters. Assuming an inflation rate of 2.5% over 15 years, SmartAsset’s inflation calculator indicates that it would cost $5,069 to purchase the same amount of goods and services as with the $3,500 monthly payment at the start of retirement. If the pension does not provide inflation protection, this retiree could face a budget deficit of about $1,500 per month by the end of retirement. In that case, a wisely invested lump sum could provide a better chance of keeping up with inflation.
However, some pensions offer protection against inflation, and that changes the balance. For example, if it has an annual cost of living adjustment of 2.5%, the value of the monthly pension option increases to $753.14. The fixed investment return required to match this then rises to 3.3%.
With a different age and life expectancy, the outcome also changes. For example, if the person making this decision were a 55-year-old woman, he or she would have a life expectancy of approximately 28 years. With an annual cost of living adjustment of 2.5% and retirement payments beginning at age 65, the value of the monthly payment option increases to $940.0227. In this case, the $500,000 lump sum, if received at 60 and invested, should yield an annual average of 4.61% to match the monthly payout option.
A financial advisor can help you make the calculations for your situation. Use this free tool to match with up to three fiduciary advisors.
If you want to decide between a lump sum or a monthly payment, you need to calculate the relative value of each option. The estimate takes into account life expectancy, investment returns and inflation, as well as any adjustments to cost of living or survivor benefits. Other factors to consider include the timing of when the lump sum will be paid, as well as the pension recipient’s debt burden, expected expenses in retirement, financial literacy and confidence in managing large sums of money.
-
A financial advisor can help you with important decisions, such as choosing between a fixed amount and a monthly pension benefit. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
-
If you don’t have a good idea of what your Social Security benefits are likely to be, it’s difficult to create a useful retirement plan. SmartAsset’s Social Security Calculator can help you fill that knowledge gap using your income, year of birth and planned retirement age.
-
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that isn’t at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
-
Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
Photo credit: ©iStock.com/skynesher
The post Should I take a $500,000 lump sum or $3,500 monthly payments for my retirement? first appeared on SmartReads by SmartAsset.
