Many retirees face the 'Lump Sum' dilemma when retiring from their company: 'Should I take a lump sum which I will manage for all or part of my retirement income - or just annuitize it (as a retirement annuity) for a lifetime income and be done with management worries?' Let's consider some of the pros and cons of each option for this pot of retirement money.
A lump sum can come as a pension plan option from work, the result of your company 401(k) savings, or your own IRA savings, and possibly as an inheritance. Your decision on how to handle retirement money has a lot to do with your psychological makeup and risk tolerance.
Directly managing income from the lump sum through your own investment choices and buying a fixed annuity represent two polar options for retirement money. Examining the pros and cons of each will help you position yourself for a possible intermediate strategy.
Managing retirement money requires time and effort. You need to research and choose investments that will both grow your money to offset inflation, minimize loss against market downturns, and incorporate income producing investments that will allow monthly and emergency withdrawals that do not force untimely investment losses.
You achieve these goals by appropriately allocating your retirement money between equity and income investments, along with holding some cash equivalents such as CDs or money market funds.
Continually rebalancing your portfolio will help you capitalize on any gains too and keep you in line with your goals.
You must keep your withdrawals low - perhaps 3% to 4% in the early years - to make sure you will not eat up your retirement money too fast. You do not want to run out of assets if you face a severe market down turn and/or you live a long life.
The worry about running out of retirement money - or nearly so - scares a lot of people. That is where your psychological makeup comes in and what makes an annuity always a realistic alternative.
Taking a fixed annuity or buying an annuity relieves you of investment management concerns by converting your retirement money into a fixed monthly payment for life. That payment can be for your life or your spouse's too. Inflation, unfortunately, will erode the value of your payments. Even at only a 2% inflation rate, a $2,000-a-month payment would lose a third of its purchasing power in 20 years.
Also, taking an annuity excludes access to your principal. That is a problem if emergencies or for unexpected expenses crop up.
The table summarizes the pros and cons of each. You can always find an intermediate strategy that satisfies some concerns of both extremes.
You can split your retirement money in two portions and buy a fixed annuity with half and manage the rest. Your fixed annuity allows you to be more 'growth' oriented in your portfolio to counter the inflation effects on your annuity payments. You can always choose later to convert the self-managed portfolio to an annuity too if you are tired of managing it.