A 2010 Towers Watson survey reported that 25 percent of Fortune 100 companies offered their employees the choice of an annuity or taking a cash option when they retire. An annuity pays the retiree monthly income for a certain period of time. Selecting the cash option gives the employee a lump-sum payment. Which choice is best for you depends on your personal financial situation.
Opting for an annuitized distribution of your retirement provides an element of security. Most retirement annuities from an employer's plan have the protection of the U.S government through the Pension Benefit Guaranty Corporation. This means that even if your employer goes bankrupt, your monthly payment does not suffer as long as your scheduled monthly distribution is less than $4,500. If you take the cash option, you could lose it due to bad financial decisions or risky investments.
Taking the cash option gives you control of your investments. If you select the annuity, the manager of the annuity decides where to invest the money. The cash option allows you to choose the beneficiaries for any remaining fund balance after your death. Choosing the annuity option typically means that only your spouse may be designated as the beneficiary.
By selecting an annuity, you spread out your tax liability over the lifespan of the payments. If you made tax deferred payments into the retirement plan, you will owe taxes on the full amount of any payments. If you select the cash option, you may be left owing a large tax bill on the full amount. You may negate the immediate tax consequences of a lump-sum payment by rolling the lump sum over into a qualified retirement plan, such as an IRA or 401(k).
Your retirement account continues to accrue interest with no action from you, whereas the cash option, barring reinvestment, does not. However, the cash option can give you the money needed to pay off, or purchase, your home or any other large expense, and you can reinvest any remaining funds to try to get higher returns than you might have gotten from your retirement account. Cashing out your retirement and reinvesting it might give you a better chance to stay ahead of inflation than taking a stream of flat annuity payments would, although you always have to remember that your reinvested capital also faces the risk of taking losses. Once you choose the annuity, you are locked into that decision and, short of selling the annuity for a substantial discount, you do not have the ability to receive a lump sum.
Before deciding whether to take the cash option or an annuity, consult a financial adviser. The only way to know which decision is best for you is to take a comprehensive look at your current financial situation and estimate your future financial needs. One option, if available, is to take a portion of your retirement account in a lump sum while leaving the bulk of it as an annuity. While not all employers offer this option, it can provide you with monthly income and the ability to manage your own money or pay off large expenses at the same time.
- Insider: Prevalence of Retirement Plans by Type in the Fortune 100
- Pension Benefit Guaranty Corporation: Your Guaranteed Pension
- CBS Money Watch: Pension Plan Lump Sum Payments - Arguments for Taking Them
- IRS.gov: Taxation of Nonperiodic Payments
- CBS Money Watch: Pension Plan Lump-sum Payments - Why You Should Avoid Them