Annuity vs Lump Sum Payout

Frequently Asked Questions

Should I take a pension as lump sum or annuity?

Compare the lump sum to the present value of lifetime annuity payments at a reasonable discount rate (5-6%). Lump sum wins if you have other guaranteed income, can invest disciplined, or have a shortened life expectancy. Annuity wins for longevity protection and limited investment experience.

What discount rate should I use?

Use a discount rate equal to expected long-term portfolio return (5-6% for balanced) or current high-quality bond yields (4-5% in 2024). Higher rates favor lump sum; lower rates favor the annuity.

Are annuity payments guaranteed?

Pension annuities from corporations are protected by PBGC up to about $87,000/year (2024 limit, age 65). Insurance company annuities are backed by state guaranty associations, typically up to $250,000-$300,000. Diversify large amounts across multiple insurers.

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How This Calculator Works

When a pension or structured settlement offers "take $500,000 now or $35,000 a year for life," the right answer hinges on returns and longevity. This tool computes the annuity's simple total (annual payment × years) and grows the lump sum at your assumed return, compounding annually over your life expectancy. It then solves for the break-even year - ln(lump ÷ payment) ÷ ln(1 + rate) - the point past which the income stream out-earns the invested cash, and flags which option wins if you live the full horizon.

The Numbers Behind the Default

With the $500,000 / $35,000 default, the annuity returns 7% of the lump annually - a strong payout rate. If you can only earn 5% on the lump, the guaranteed stream is hard to beat over a long horizon. Flip your assumed return to 8% and the lump pulls ahead because compounding outruns the fixed payments. The lesson: this decision is exquisitely sensitive to the return you can realistically and safely earn, not the return you hope for.

What This Math Leaves Out

Inflation: a fixed $35,000 loses roughly half its purchasing power over 25 years at 3% inflation - the tool's annuity total is nominal, not real.

Taxes: lump sums can trigger a large taxable event; annuity payments are taxed gradually. The after-tax comparison can reverse the answer.

Sequence-of-returns risk: the model assumes a smooth return every year. A market crash early in retirement can permanently impair an invested lump sum.

Insurer credit risk: an annuity is only as safe as the carrier (and your state guaranty association limit, often $250,000–$300,000).

When Each Option Wins

Lean annuity if you value guaranteed income, expect to live long (good health, family longevity), lack investing discipline, or have few other stable income sources. Lean lump sum if you have other guaranteed income covering essentials, want to leave money to heirs (annuities usually die with you), can invest prudently, or have a shortened life expectancy. A 50/50 split - partial lump, partial annuity - is often the underrated middle path.

Questions to Ask Before Deciding

Does the annuity include a cost-of-living adjustment or a survivor benefit for a spouse? Both materially change its value.

Is the pension underfunded? A weak plan sponsor raises the case for taking the lump and self-managing.

What is the implied internal rate of return of the annuity at your honest life expectancy - not the optimistic one?

Could rolling the lump into an IRA defer taxes and preserve flexibility you'd lose by annuitizing?

Annuity vs Lump Sum Payout

Frequently Asked Questions

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