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Take the money and run? PDF Print E-mail

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Should I take my retirement money in a lump sum or as an annuity?

April 27, 2005: 12:27 PM EDT By Walter Updegrave, Money Magazine NEW YORK (CNN/Money) - I have a choice of taking my retirement money in a lump sum or an annuity. Which do you recommend and why? -- Virginia Boswell, Vicksburg, Mississippi It's a vexing question for many people at or near retirement who are pulling money from their company plans: take their lumps now or take the money in the form of monthly income payments, typically for the rest of their lives. Let's take a look at the options.

The lump sum option First of all, if you take a lump sum, you'll presumably transfer it into an IRA rollover account, or better yet, have your employer do a direct transfer to the IRA account.

That way, you won't owe taxes on the transfer and your money can continue to build free of taxes until you withdraw it. Assuming you do this, you are then faced with the question of how to invest your money so that it supports you throughout your retirement.

This can be a challenge. Invest too conservatively, and your stash might not generate enough of a return to sustain the level of withdrawals you need for a comfortable retirement. Invest too aggressively, and a market downturn could hand you big losses that, combined with your withdrawals for income, could mean that you would run out of money before you run out of time.

As much as possible, you want to keep withdrawals moderate to low, especially early in retirement so your portfolio doesn't take a big hit early on that it may never recover from. Similarly, I can tell you that you want to be diversified, owning a variety of different types of stock and bond funds. But the proportion of stocks vs. bonds is also partly a matter of your risk tolerance. For more guidance on this issue, I suggest you go to the T. Rowe Price Retirement Income Calculator.

There, you'll be able to try out different withdrawal rates on different types of portfolios and get an idea of the odds of each portfolio sustaining a given level of income during retirement. Taking an annuity Taking an annuity, on the other hand, typically relives you of the investing question by converting your retirement sum into a fixed monthly payment. That payment can be for your life or it can continue as long as either your or your spouse is alive.

The prospect of a fixed income might sound like the safer option at first glance, but remember: inflation will erode the value of a fixed monthly payment over time. For example, even at a relatively modest inflation rte of 2 percent, a $2,000-a-month payment would lose about a third of its purchasing power in 20 years. What's more, once you take the annuity, you no longer have access to your principal.

You've traded it in for income. That's not a good idea if you don't have sufficient other resources to tap in the case of emergencies or for unexpected expenses. See if you can do both So what would I do? I wouldn't make a "this or that" choice. I'd consider hedging my bets by doing both -- that is, taking the annuity with part of my money and then investing the rest on my own (using the T. Rowe Price calculator as a guide for developing an investing strategy). As a practical matter, you'll first have to see if your employer will go along with this plan. Your employer might only offer an all-or-nothing deal, that is, take it all in a lump sum or take it all in income.

If that's the case, you can roll over the money into an IRA rollover and then decide how much to invest on your own and how much to peel into a payout annuity (or an immediate annuity as it's also known), which you can buy from any number of insurers. Even if your employer does allow you to take a portion of the money in an annuity, you want to be sure that the employer is offering a competitive annuity rate -- that is, that the income you're getting for whatever sum you're putting into the annuity is on par with what you could get by buying an annuity from an insurance company. One more wrinkle: a fixed or variable annuity? You'll also have decide what kind of payout annuity to buy: fixed or variable.

A fixed-payout annuity offers the stability of a steady payment, but it's guaranteed to lose value with inflation.

A variable payout annuity pays an income that has the potential to rise over time, which can keep your payments ahead of inflation. That payment can go up and down in the meantime, however.

Again, I think hedging makes sense, so consider splitting it between a fixed-payout and variable payout annuities. This will give you some stability and some potential for growth. For more on how this kind of arrangement might work (and for an explanation of the not-exactly-intuitive way that variable annuity payments work), check out a story I did on a similar topic last year for Money Magazine. You've got some research and then a lot of thinking to do.

But better to deal with all this before making your decision than finding out afterward that you made a lousy decision that you can't undo.

 
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