S2 E45: Lump Sum vs. Annuity: Which Should You Take?

You’re listening to The Wealth Mindset Show where Hixon Zuercher Capital Management’s team of finance professionals, portfolio managers, and a life coach come together to tackle complex topics in finance and retirement planning so you don’t have to. From investment strategies and wealth management to tax planning, retirement income, and aligning your money with your values and purpose, the Wealth Mindset Show offers the tools to thrive.

Austin Wilson:

All right. Hey, hey, hey, welcome to The Wealth Mindset Show where the Hixon Zuercher team will have conversations on managing wealth, navigating retirement, and making smart decisions for a secure, meaningful future. I’m Austin Wilson, chief investment officer at Hixon Zuercher Capital Management.

Josh Robb:

I’m Josh Robb, Director of Wealth Management at Hixon Zuercher Capital Management. Joining us today is Jessica Hinks, one of our senior wealth advisors here, and we are going to be talking about the options of taking a lump sum versus a monthly payout, like a pension or an annuity stream.

Austin Wilson:

Yep.

[0:54] – Life Updates: Office Visitor, Routines, & Fall Sports

Josh Robb:

So that’s going to be our topic today. But first, update on how everything’s doing. Jess, anything in your life changing or anything exciting?

Jessica Hinks:

Well, you guys know that my daughter Allie got to come hang out at the office this morning.

Austin Wilson:

Yes.

Josh Robb:

She was the best employee for hours.

Austin Wilson:

That’s right. Yeah.

Jessica Hinks:

She honestly probably was.

Josh Robb:

Yeah.

Jessica Hinks:

Yeah. She went around the office with a tally sheet and asked who’s the coolest person in the office? And of course, all the adults chose the small child because we all have souls.

Austin Wilson:

Yes. And she’s the best.

Josh Robb:

Yeah.

Jessica Hinks:

She is the coolest.

Austin Wilson:

She was the coolest in the office.

Jessica Hinks:

But when she brought it back to my office, she put all the tallies behind my name because she wanted me to win.

Austin Wilson:

Oh!

Josh Robb:

Sweet.

Austin Wilson:

That was super nice of her.

Jessica Hinks:

That made my day.

Austin Wilson:

Yep. Josh.

Josh Robb:

We’re getting back in the swing of things. School’s starting back into routines, which I’m a fan of, but we’re also kicking off all the fall sports. So back to a busy life.

Austin Wilson:

Yeah.

Josh Robb:

Yep. It’s good though.

Austin Wilson:

Our oldest just turned nine, so they’re getting older. The more you feed them, the more they grow, right?

Josh Robb:

Yes, that is how it is.

Austin Wilson:

So we’re navigating life with a nine-year-old who’s sweet, smart, and a little too smart and sassy sometimes because she’s that way.

[2:03] – The Options Given to You with a Pension: Lump Sum or Annuity

But yeah, today, if you’re nearing retirement, you got a couple options at a lot of these. First of all, we’re specifically talking in a lot of ways of there’s multiple ways of buckets of money you can have at the end of your retirement, right? You’re going to have a 401k.

Josh Robb:

Mm-hmm.

Austin Wilson:

Nowadays, it’s less common, but a lot of places still have a pension.

Josh Robb:

Yes.

Jessica Hinks:

Mm-hmm.

Austin Wilson:

And it’s really, what do I do with these sort of amounts of money? These are large lump sums of money, just chunks of change and you have multiple options you can do with them. That’s what we’re talking about today.

Josh Robb:

Yes.

Austin Wilson:

The one option is to invest it and take distributions from that, growing it over time. The other one is to put it in some sort of vehicle which gives you a more predictable payout. So those are the two options we’re talking about today. The answer, we’re just going to wrap this episode up right now.

Josh Robb:

It’s a very fast answer. It depends.

Austin Wilson:

It depends.

Josh Robb:

That’s what I like about this question.

[2:54] – Why the Lump Sum Appeals to So Many Retirees

Austin Wilson:

It depends. No, it’s a little bit more nuanced to that. So we are going to talk about the factors that go into that, but it’s really a major decision and you can really make this decision mainly once because they’re not completely, but mainly and-

Jessica Hinks:

You generally can’t take it back. It is true.

Austin Wilson:

So that is where it’s a big decision that people need to be informed on how to make. So we’re going to talk about what’s going on there. So first of all, let’s talk about the lump sum option first because this is the option we talk to a lot of retirees about. So just talk a little bit about what that is and how that can actually help a retiree in the long term.

Jessica Hinks:

Sure. And to start, you did say that the pensions are less common than they used to be, certainly so in the private sector, but we still see a lot of these in the private sector versus the public sector being less common. This is actually extremely common for teachers and state employees. So if that applies to you, you might’ve heard this lump sum actually referred to as a plop, a partial or a whole. So that’s another piece of terminology that people might hear. So the lump sum is just rather than taking a monthly income stream, you take your entire balance and they quote you a balance at retirement and you roll it over to an IRA. So the funds move from one location to another where you then get full control. You get complete flexibility, but you’re trading that for sole responsibility.

Austin Wilson:

Absolutely.

Jessica Hinks:

And that’s really what it is.

Josh Robb:

Yep. And kind of like you mentioned, most of the time when you elect for that decision, it cannot be undone. So if you take a lump sum and roll it out of that pension framework, most of the time it cannot go back into that pension framework.

Austin Wilson:

Right.

Josh Robb:

So again, once you made that decision, it is probably no longer a decision that you can undo. Now there are ways, once you have a lump sum, there’s annuities and things like that, you can generate your own income stream, but that pension itself is probably no longer available to you.

Austin Wilson:

So Josh, compare that to the more guaranteed, some would call it fixed, but maybe there’s some different ways you can do that as well, but the pension or annuity approach compared to the lump sum.

Josh Robb:

Yeah. So the other option, so again, the public sector, teachers, government employees, a lot of times the pension itself will provide the income stream. And so they’re not necessarily taking it and creating or buying an annuity for you, but within the structure of that pension, they’re going to pay out on a set amount monthly to you based on what you’ve earned and accumulated through that. And a lot of times before you make that decision, they’re going to show you that option. If you take this as a monthly income stream, here’s how much you’re going to get.

[5:30] – Taking the Lump Sum: Inflation Protection

Austin Wilson:

And the key things to look for there are, is there a cost of living adjustment? So that means will it go up over time as inflation happens? Will your income stream go with inflation or try to keep up with it?

The second thing is what type of protections are there for if something were happen to you? So are there survivor benefits? So a lot of the pensions will include some sort of survivor benefit for your spouse or your elected person. So if you do a 50% survivor benefit, if you’re getting $2,000 a month, if something were happen to you, your survivor would get $1,000 a month, 50% of what you were getting. And a lot of them will have options on how much you want to elect to protect for that survivor. And the more you elect to protect, the lower your payment will be because that’s part of that calculation.

Austin Wilson:

So it sounds like obviously this choice between the two options is a very impactful choice when you’re looking at your long-term financial plan. This can impact your income in retirement. This can impact really your risk, how risky you are or aren’t invested there. Your estate planning can look very different. Again, you mentioned spousal protection, spousal benefits, that can be very different between that. And then flexibility is another one, right? If you have it essentially tied up in a pension or annuity product, you don’t have as much flexibility to, “Hey, maybe I want a big purchase here or there.” You’ve got to come at it from other directions there. So let’s talk first about the lump sum a little bit more. So again, when you take that lump sum, that money becomes yours and you have a lot of flexibility to then decide or work with someone qualified to do so, how it’s invested, so what you’re invested in there, when and how you withdraw it, how much you withdraw it, and then what happens to it after you pass away.

So talk about those things a little bit. And then you mentioned a little bit the cost of living thing. Talk about how that’s maybe not as important of a factor to consider when we’re looking at putting it into a lump sum investing in the financial world rather than leaving in it essentially what’s an insurance product.

Josh Robb:

Yeah.

Jessica Hinks:

Well, with those cost of living adjustments, I would honestly be a lot more prone to recommend the annuity payments if there were good cost of living adjustment plans out there. I’ve yet to see one with an appealing, just that raise, we’re going to call it the inflation rate. For some people it’d be much more appropriate. But when you invest it for growth, you’re able to mitigate that risk of inflation eating your assets. So when you take a lump sum and invest it, you also have to be very conscientious with your professional to get good buckets. Some of it needs to be invested really aggressively for you when you’re 90 and other parts of it need to be more conservative, that way you know you can provide for a steady income stream when you need to take those regular monthly paychecks from your portfolio.

Josh Robb:

Yep. And then with that is the sense of responsibility. You mentioned that that’s the big trade-off is you’re taking sole responsibility that you’ll manage this asset to last as long as your plan needs it to. And that’s the big trade-off is you’re removing, in a sense, that delegation of responsibility and it’s coming back to you. So it’s up to you to find those buckets that says, “I need X amount growing so that I have money when I’m 80, 90 years old.” And controlling your spending because that’s the other one is lump sums because you have access to all of it, you can also spend more potentially than you should because there is no stop point. Whereas the annuity or the pension says, “I’m giving you X amount per year and that’s it. You can’t take any more.”

Austin Wilson:

Right.

Josh Robb:

The lump sum says the whole thing’s yours and you have access to it. It takes discipline.

[9:10] – Taking the Lump Sum: Legacy Planning 

Austin Wilson:

Another thing is when we think really long term, we think about leaving a legacy. Our mission is to store generational wealth. So we’re talking about things for the next generation, even beyond ourselves. When we think about legacy planning, this is very, very different as well because while your spouse may receive some extended benefits after you pass away, if you have a pension or an annuity product and you can, like you talked about, adjust how much that is going forward, typically after that, it’s gone. Most cases-

Josh Robb:

Most pensions do not have a…

Austin Wilson:

… there are few that go beyond that.

Josh Robb:

They have some at the end.

Jessica Hinks:

Yeah. They have certain life periods, whether it be five year, 10 year, 20 year, but most people select the spousal. And so if you retired and immediately started your pension to be a monthly payout with a spousal benefit and you and your spouse were in an accident a month after retirement, your adult children could actually be left with nothing. Your pension could have been $500,000 and if you didn’t select a term certain…

Josh Robb:

Term certain. Yeah. Certain terms is where it is, yeah.

Jessica Hinks:

If you didn’t select term certain, that benefit’s gone.

Austin Wilson:

Yeah. So that’s where it comes into if you take the lump sum and then you essentially turn this into an IRA, a retirement account, you get to decide where that goes and what happens to it after because, and especially if you’re working with someone who’s put together a great plan, the plan is for that money not to run out. So there’s probably and hopefully going to be some assets left over to go to the next generation to leave a legacy for your family. So I think the flexibility there is really, really key. And then again, yes, you talked about the flexibility with large purchases and adapting to life changes, unexpected costs, things like that you can do with the lump sum, the net you can’t if you’re at a fixed sort of things there. And then Jess, you wrote a blog actually last year about a retiree that took a lump sum and then that account was being depleted faster than expected. So talk a little bit about that story.

[11:04] – The Biggest Risk Isn’t the Market, It’s You

Jessica Hinks:

This was a long time ago. It was actually before I was a financial advisor. It was my first job out of college working in client services, but I watched another advisor go through it that I was assisting, but essentially had a new client. And the tough thing about new clients is you do your absolute best to recommend what’s best for them, but you don’t know people that well over short periods of times. So there was no cost of living adjustment. The client had appetite for risk. It seemed like the lump sum annuity was going to be best for their long-term goals. So we selected the long-term annuity. Oh, apologies. We selected the lump sum, the big pot of money. I think within two years, this young retiree had depleted the entire account and then there was nothing. He had to wait for social security to kick in, maybe go out and get a part-time job.

He had no self-control over those dollars and it was gone. And that advisor, I had heard him say if we had just chosen the pension annuity option, at least he would’ve been getting a monthly paycheck of something. It wouldn’t be zero. But you don’t know. Sometimes you just don’t know as an advisor or yourself.

Josh Robb:

Sometimes you explain and warn along the way and they just either don’t care to listen, don’t have that ability to stop themselves, don’t fully understand what’s happening.

Jessica Hinks:

And I would argue that that man did not think he would do that going into it. It was not his plan.

Josh Robb:

And no one plans for this. Yeah.

Jessica Hinks:

He had no preconceived notion. Just one thing rolls and happens and happens and it just snowballs.

Josh Robb:

Yep.

Austin Wilson:

It’s one of those things where it seems like if you’re about to retire or you are retiring, you can be really diligent for your working career and be getting your assets set aside to have that long-term trajectory of what you need to do. So very good at the saving part of things, but you haven’t had to be as disciplined on the spending side of things when you’ve had an income. And then you have to start being disciplined no matter which option you choose once you retire.

Josh Robb:

And a lot of people, when you take a lump sum, it’s a big chunk of money. Maybe you’ve never actually had that large a chunk of money set in front of you. So you’ve never even been tempted in a sense to manage that, to make those spending decisions because up to that point you were limited on what you could actually spend. And so you’re right, people may not even fully understand themselves on how they would react to that money.

Jessica Hinks:

Yeah. I feel like pensions, they’re monopoly money until they’re rolled over and accessible and then wow, then they really feel like dollars.

Austin Wilson:

Absolutely.

Josh Robb:

Have you ever felt overwhelmed by the complexities of managing your wealth? You’re not alone. At Hixon Zuercher Capital Management, we specialize in helping affluent families and individuals navigate the complex challenges of managing their finances. Wealth management is all about combining thoughtful financial planning with active investment management to help you reach your goals. Our process is designed to guide you toward what truly matters because we believe wealth isn’t the destination. It’s a vehicle for something much more meaningful in your life. Achieving your dreams requires careful planning, smart decision making, and access to high quality investments. That’s where we come in. We understand that complex financial situations call for deep expertise in investing, tax strategies, and retirement planning, but our approach goes beyond that. We integrate your financial goals with your core values, helping you visualize the possibilities your wealth can create for a secure future. If you’re ready to take the next step, visit hzcapital.com/start to see if we’d fit in to your needs and to schedule a call with us. Again, that’s hzcapital.com/start. Now let’s get back to today’s episode.

[14:52] – When the Pension Annuity Might Actually Be Better

Austin Wilson:

Let’s transition from that story where it seems like if you would’ve chosen maybe the pension or annuitized option there maybe could have extended that trajectory for the retirement for a while. So there are examples where that option might actually be more attractive.

Josh Robb:

A lot of people think as advisors, we would always say, “Hey, take the money and invest it. You’re always going to do better.” And math says that’s normally true just when you look at the ability to invest because again, pensions have to be very conservative in order to guarantee that payout. So math says being able to invest more in equities is going to give you a better return over the long term, but math isn’t the only thing. So as advisors, the answer isn’t always on paper, “You’ll end with more money if you do this.”

It’s what do you need to best help you achieve your goals? What do you need for your unique situation? And you’re right, sometimes that pension or annuity, that guaranteed income stream is the exact solution they need, whether it’s circumstantial for them, whether it’s they have other assets that they can use for those big items and those one-offs, and this just becomes their baseline, which is, to me, the most use case for these pensions and annuities is they say, “Hey, if I look at my spending, I need $2,000 a month to take care of my utilities, my bills, all just my basic living.” And if you have that pension that can do that, and then I have all these savings outside, that becomes what you use for all your fun spending and you have that control. But you always know no matter what, my basic needs are taken care of. That’s where these things come into play the most, and I think they add the most value for people.

Jessica Hinks:

And for a different perspective, this is something I think I’ve learned and seen more over the last few years. Some people do not like dipping into their portfolio. They’ve been accumulating all their life and the minute they have to start deducting from it, no matter how many hundreds of thousands they have, it’s anxiety, anxiety, anxiety. And I’ve seen where fixed income payments feel like permission. And so if I see someone who has those traits and perhaps if they have other flexibility with big portfolio options, I might suggest they elect an annuity just so they allow themselves to spend something.

Josh Robb:

Yeah, for sure. And it comes back to, again, and that’s understanding each individual person, how they react to money, how they view it, what their spending habits are, all those things to decide which one makes sense because it is no straight answer across the board for anybody. So you’re right. It depends is really-

Austin Wilson:

It depends, yeah. Yeah.

Josh Robb:

… the answer here because you’re right, there’s so many cases where you look at one or the other and say, “Hey, we should have done this or that, or this would be the best choice for you.” But again, what if there’s a need down the road where, “Man, if I only had some more money I could access, I could do this or do that.” Well, that lump sum would’ve been… You just don’t know those things on the front end. So you got to make the most educated decision you can on the most likely things you’re going to experience or need to take care of.

Jessica Hinks:

All right. Question for you. What would you do? We’re all enrolled in a pension system right now, Social Security.

Austin Wilson:

Yes, we are.

Jessica Hinks:

If Social Security offer me a lump sum in lieu of the income stream, I would take it and run now.

Austin Wilson:

Absolutely.

Jessica Hinks:

You would, 100%?

Austin Wilson:

100%. Today.

Josh Robb:

Are we under the assumption that Social-

Jessica Hinks:

Today at retirement, whatever day they allowed it early?

Austin Wilson:

Totally.

Josh Robb:

… Security has the same issues it has going forward or just treat it like a pension?

Austin Wilson:

That’s going to get better.

Jessica Hinks:

No, just assume there is expected solvency through your retirement.

Josh Robb:

Okay. I actually would maintain it because I like the balance of the two. I’m going to trust myself to add and accumulate, and that becomes my extra money and then my safety net, my base is over there, and that what gives me the security and peace of mind and that’s that.

Jessica Hinks:

Okay. We will circle back in 30 years.

Austin Wilson:

Yeah, that’s right.

Jessica Hinks:

And we will see 40 years, 50 years, and we’ll see who comes out ahead. I’m not even going to be claiming Social Security…

Austin Wilson:

No, this is a great example of it depends, right?

Josh Robb:

It depends.

Austin Wilson:

Because two out of the three of us chose one thing, the other one says the other. It depends because there’s so many variables there, but Jess and I are probably thinking mathematically, the government, I can trust myself at managing those investments a lot better than I can trust the government.

Jessica Hinks:

Josh is so much older than us, so much closer to Social Security.

Austin Wilson:

We have a long way to run…

Josh Robb:

That’s really what it is. That’s why solvent for me or you guys?

[19:16] – Questions to Ask Before Making Your Decision

Austin Wilson:

That’s right. Yeah. That’s funny. Well, good question, Jess. I like that. I like that. So let’s ask some questions to ask ourselves as we’re beginning to get ready to make that choice. Lump sum versus pension annuity, question that we already kind of answered.

Josh Robb:

Yes.

Austin Wilson:

Am I disciplined?

Josh Robb:

Yep.

Austin Wilson:

If I’m disciplined, maybe I can have a little bit more flexibility.

Jessica Hinks:

Are we playing 10 fingers?

Josh Robb:

That’s it. I disciplined her.

Austin Wilson:

I put my finger down. I don’t know. Josh is putting his down. He can’t trust himself.

Josh Robb:

No. Nope. I want the lump sum.

Austin Wilson:

He wants the fixed payment. How important is flexibility? Again, favoring the lump sum, the flexibility side of things, but if you don’t need it, you can maybe lean towards the annuitized product there. Do I have other income sources? Key things to know there. Again, if you’ve got those other options, you can lean one way or the other. Legacy goals, that’s a huge difference in what your flexibility is there. And then am I comfortable with market volatility? Do you constantly watch? If your life is depending on, your living, your spending is depending on money coming out of the market into your checking account, volatility feels a little different than it does when you’re working, right?

Josh Robb:

Mm-hmm.

Austin Wilson:

So am I comfortable with that? So I guess in general, you guys nailed it. Know your clients. It’s your guys’ job. Know yourself if you’re trying to do it on your own, because answering those questions are going to be very important in determining which is the best decision for you there. And my overall thought as it relates to this is, and it kind of relates to what Jess and I chose in terms of our options there is, okay, well think about the business who is selling this product or managing the pension or the annuity. So they are giving you a fixed payout, then what are they doing with the money to give you that fixed payout?

Josh Robb:

They got to earn more than that.

Austin Wilson:

They got to go earn more than that, and you’re giving up that difference, and you just have to be okay with it. There’s a lot of reasons why you give that up, stability, guaranteed income, all these sort of things. I would say if you’re okay taking on the more risk by yourself and doing things, hopefully working with an advisor, as we’ve talked about many times, they would be able to manage this and make a plan that is invested appropriately. But taking on a little bit more risk, you should be able to earn a substantially higher return over the long term while giving yourself that flexibility at the end of life to leave a little bit of a legacy there. So that’s the way I lean on it and that lean towards my decision as Jess put us on the spot there, but it’s just math, right?

Math does not answer the question for everyone, but for some people it does, and that’s where I’m at. Any wrap up thoughts?

Josh Robb:

No, just when you have those decisions, don’t rush into it, sit down, take some time to think through it. That’s the key, is some people just wait or they ask their friends and they just do what they did. Think about your situation before you make that decision.

Jessica Hinks:

And honestly, the paperwork is so scary.

Josh Robb:

Mm-hmm.

Austin Wilson:

Yeah.

Josh Robb:

Oh yeah, not…

Jessica Hinks:

You have to get big thick packets with confusing terminology or you have to click through 300 things online, sit down, take it bit by bit, or do it with someone, like an actual professional. It does not have to be scary if you’re walking alongside with someone.

Austin Wilson:

Thanks for listening this week. If you found value in our conversation, don’t forget to subscribe. We put episodes out frequently and hopefully you find value in that on whatever platform you’re on so you don’t miss any episodes there. You can also visit us at thewealthmindsetshow.com for more resources, or if you’re ready to check out what we do at Hixon Zuercher Capital Management, visit hzcapital.com and follow us on social media. We’d love to connect there. Otherwise, we will talk to you next episode.

Josh Robb:

All right. Have a good day. Bye.

Speaker 1:

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