Payment plan — lump sum or annuity? It’s no easy decision

There’s a reason roughly 40% of Americans say they have less than $ 1,000 or so in liquid savings: Many people spend whatever money is available. When a windfall comes their way — in the form of lottery winnings, tax refunds or retirement- plan payouts — there’s a temptation to use it to pay down debts, go on vacations or give money to kids.

Those aren’t necessarily bad choices, but they can mean assets get whittled down, especially in the case of retirement plans. The latest evidence comes from a survey by MetLife of roughly 1,000 people, mostly at or near retirement age. The respondents were given the option of taking retirement money, primarily pensions, either as a lump sum or as ongoing annuity payments, typically stretching for as long as they live.

Most respondents indicated they made wise decisions, but one- in- five retirement- plan participants who selected a lump sum said they already had spent the money. The people who depleted their lump sums did so over just 5.5 years on average.

Some recipients used their retirement money for relatively short- term purposes. More than one- quarter of the people who spent lump sums used the money to pay down credit cards or other debts. Other uses included home improvements/ repairs, new vehicles or vacations. Nearly onequarter of these individuals gave money to friends, family members or charity groups, and some said they regret those decisions.

The survey was conducted to understand how people view the lump sum/ annuity decision and related issues. Many people who took lump sums didn’t realize how quickly they would go through the money or underestimated how long they might live.

“People will talk about how long their parents or grandparents lived, but when they talk about their own longevity, they have a different perspective of it,” said Roberta Rafaloff, a MetLife vice president focusing on income annuities.

Among respondents who opted for a lump sum, the most common reason was wanting to maintain control over the money, including those who thought they could generate higher returns compared to what an annuity paid. People who chose lump sums also described themselves as more accepting of stock market changes and other risks compared to those taking annuities.

“People will look at their 401( k) statements and pat themselves on the back saying, ‘ Wow, I’ve saved $ 200,000,’ ” Rafaloff said. “They don’t understand what that equates to in terms of guaranteed income.”

Many factors go into the lump sum/ annuity decision, and some of these aren’t easy to estimate. As a general rule, people in good health and those with high family longevity should consider taking annuities, said Jeremy Kisner, a certified financial planner at Surevest Wealth Management in Phoenix. As noted in the MetLife report, annuities also can make sense for people with low risk tolerance and those not overly concerned about leaving money to beneficiaries. In contrast, lump sums tend to make sense for people in poor health or low family longevity, as well as those who place greater value on leaving money to heirs, Kisner added.

And there are other considerations. Retirees and prospective retirees also should take account of their other assets and project how much money that will generate, assuming a sustainable withdrawal rate of 3% to 5% annually, said David Daughtrey, a certified financial planner at Copperwynd Financial in Scottsdale, Ariz. If personal investments and Social Security aren’t enough to cover budgeted expenses, then an annuity could fill any gaps.

But when considering annuities, it’s important to recognize that today’s payouts are historically modest, reflecting low interest rates in general, Daughtrey said. In other words, annuities purchased today might not cover future expenses if consumer prices begin rising at a faster clip.

A recent study by the Employee Benefit Research Institute came to an unusual finding: People at the top and bottom of the savings scale — those with the highest and lowest assets — are more likely to buy annuities than those in the middle.

The study focused on immediate annuities, or those that start paying a regular income as soon as purchased.

People with minimal assets recognize that they could run out of money in retirement and thus are inclined to buy annuities, according to the report authored by Sudipto Banerjee of the EBRI. People at the top of the savings range, in contrast, can afford to buy annuities even after leaving a significant legacy to heirs. These individuals expect to have longer lifespans, possibly because of more favorable lifestyles.

People in the middle “generally face more uncertainty about their retirement adequacy, and so they are more likely to hold on to their savings for precautionary purposes and perhaps also for some hope of leaving a financial legacy for their heirs,” the report said.

“They don’t understand what ( savings from a 401( k) plan) equates to in terms of guaranteed income.” Roberta Rafaloff, a MetLife vice president focusing on income annuities

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