Lump Sum or Annuity? Consider the Pros, Cons Carefully
Most financial advisers would agree that getting a lump sum payout, whether it’s lottery winnings or a lawsuit judgement, is better than getting payments over time through an annuity. But there are both pros and cons to getting all your money at once, and you should weigh the risks carefully against the benefits.
One of the biggest advantages of getting a lump sum payout is that you get your money immediately and can invest it the way you want. When you take an annuity, the money is invested conservatively to guard against losses, which limits the potential upside of the money. Also, if you want to make a large investment, such as buying a business or an apartment complex, the yearly annuity may not be enough to let you do so without borrowing money.
Another advantage to taking a lump sum payment is that you have the money there when you need it, if you run into a bad spot of luck with a health issue or a bad investment, you could wind up in financial distress if you have to wait for your annual annuity payment. Though you can borrow against it, such a move costs money. You also can look into selling your annuity, but that usually comes with a discount on the amount of 10%, not counting any fees. When you have the money at your fingertips, you can tap it as you need it.
One of the disadvantages if you opt for a lump sum payout over an annuity is that you usually get less guaranteed money. For example, the lottery payouts you see advertised on billboards and in TV commercials are the total amount you get if you take the annuity option. The jackpot is much lower if you take the lump sum.
Another potential disadvantage when taking a lump sum payment is the potential to lose the money. If you don’t know much about finances and investing, it can be easy to make bad choices, and there also will be any number of unscrupulous people looking to take advantage of you and your newfound wealth. With an annuity, you have a guaranteed income for many years to come. For example, when you win a Powerball or Mega Millions lottery jackpot and take the annuity, you get annual payments that increase each year for 30 years.
One additional potential disadvantage of taking a lump sum is taxes. If you take your winnings all at once, you have to pay all the taxes at once, which usually includes 25% withholding for federal taxes and another 6-9% for state taxes. Taking the annuity option spreads out your tax bill and also could mean lower taxes depending on the amount.
It’s important to take all these factors into consideration when deciding whether getting a lump sum payout is a better option than an annuity.