What Are the Differences Between Lump Sum vs Annuity?

What Is a Lump Sum?

A lump sum is a one-time payment. It’s a single, large sum of money that you receive all at once. The lump sum amounts to everything that you’ve earned during your employment, plus any interest and investment returns. With a lump sum payment, the individual will have complete control of investing and spending their money. This leads to the potential for greater returns on investments. 

What Is an Annuity?

An annuity is a series of payments made at regular intervals over a certain period of time or until death—whichever comes first. An annuity can start as soon as one month after the date of your retirement. It offers predictable payments that come at fixed intervals. Annuitants are guaranteed their original investment amount as well as any accrued interest. Payments also continue even if the invested funds perform poorly.

How Does a Lump Sum Work?

When you take the lump sum, you are responsible for turning that money into an income stream that will last you throughout retirement.  You can invest the lump sum in stocks, bonds, mutual funds, real estate, or any other type of investment vehicle depending on your risk tolerance and financial goals.  You will need to make regular withdrawals from these investments to cover your living expenses.

How Does an Annuity Work?

When you receive an annuity, the payments are made to you automatically, typically through checks or direct deposits into your bank account.  You don’t have to do anything to receive them. The insurance company will also manage your investments for you, making it easy for you to receive regular payments and maintain a steady income stream.

Similarities Between Lump Sum and Annuity

There are similarities between lump sum and annuity, these are:

Ways to Receive Income During Retirement

The biggest similarity between the two options is that they are both ways to receive income during retirement. Both the lump sum and the annuity can provide you with a steady stream of income to cover your living expenses. You will need to make withdrawals from your savings/investment accounts for a lump sum, and a series of annuity payments are made automatically every month.

Income Amounts

The other similarity is that both the lump sum and annuity amount can be substantial—you don’t have to settle for less if you choose one over the other.  You can use both options to generate income from your retirement savings. With the lump sum, you will need to do some work to manage your own investments. 

Taxes

Both the lump sum and annuity are taxed as income. The money you receive as a lump sum is considered taxable income in the year you receive it. Annuity payments are also taxable, but the tax is spread out over the years that you receive them.

Differences Between Lump Sum and Annuity

There are also some key differences between a lump sum and annuity:

Payment

The biggest difference between the two options is that the lump sum is a one-time payment, while the annuity is a series of payments. This means that the annuity will provide you with income for a longer period of time than the lump sum.

Investment Options

The lump sum gives you more investment options, as you are in control of where to invest your money. With an annuity, you are restricted to the investment options that are offered by the insurance company. With the lump sum, you can take advantage of your own investing knowledge and choose an ideal mix of investments for generating income during retirement. 

Control of Your Money

Another difference between a lump sum and annuity is that with a lump sum, you have control of your money. You can use it for any purpose you choose, including withdrawing it all at once and spending it however you want.  An annuity gives the insurance company control of your money. The company will invest it for you and make regular payments to you.  This can be helpful if you don’t want to manage your own investments, but if you want to control how and when you spend the money in your retirement accounts, a lump sum will be more beneficial.

Guarantee

Another difference is that the lump sum will come with a guarantee, while the annuity does not. With the lump sum option, you should be able to withdraw at least as much money as you put in—minus any fees or penalties for early withdrawals.  But this doesn’t apply to the annuity. If your investments are doing poorly when it comes time to make the first payment, then you may not receive as much as you expected.  This could be a big problem for retirees who need their income stream to last as long as possible.

The Importance of Understanding the Difference Between

When making the decision between taking a lump sum or an annuity, it’s important to understand the difference between the two options.  Understanding the difference between an annuity and lump sum is important when making the decision about what’s best for your retirement.  If you’re looking for a steady stream of income that will last for a long time, then the annuity might be the better option. But if you want more control over your investments, then taking a lump sum may be the better choice. Now you have all the information you need to know about annuity and lump sum . You can use this knowledge to make decisions for your own retirement.

Which Is a Better Option?

When it comes time to make a decision about what’s best for your retirement, you have to weigh the pros and cons of each option.  Here’s a look at some of the pros and cons of taking a lump sum vs. an annuity:

Lump Sum

Pros:

  • More control over investments 
  • Can withdraw the money for any reason at any time 
  • Better chance to earn interest on your investments 

Cons:

  • Higher fees and penalties for early withdrawals 
  • Potential guarantee may not cover losses in market value 

Annuity

Pros:

  • Guarantee that you will receive a certain amount of income each month, which you can’t find with a lump sum 
  • You can benefit from professional investment advice on how to invest your money 

Cons:

  • Payments are stable, but not necessarily more than the interest you would earn by investing on your own 
  • No control over your investments 

The Bottom Line

If you need income for many years, then an annuity may provide the steady stream of monthly income that you’re looking for. But if you want to make sure your money will last as long as possible, then take the lump sum and invest it yourself. There are benefits and downsides to both options, so understanding all the pros and cons is essential before making a decision. Only you can decide what’s best for your own retirement. But with the information in this article, you’re one step closer to making an informed decision.

The lump sum is an amount of money that is given to someone in one large payment.
An Annuity is an arrangement where a series of regular payments are made to you (periodic, steady stream). The payments can be made monthly or annually.
The key difference between a lump sum and an annuity is that with a lump sum you have more control over your investments, while with an annuity you have a guarantee that you will receive payments for a certain amount of time.
If you want more control over your investments, then taking the lump sum option may be better for you.
If you want a steady stream of income that will last for a long time, then an annuity may be the better option.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.