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What is a lump sum payment?

If you’ve got a pension plan, such as a 401(k) or an IRA, and you’d like to access the vehicle’s funds, you can typically choose between monthly distributions, a lump sum payment or an annuity. The method you select should consider your short- and long-term savings goals so that your financial situation is in no way compromised. In this review, we explore how lump sum payments work.

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Lump Sum Defined

A lump sum payment is single payment of a sum of money. Lump sums are generally used for retirement plans, inheritances and even lottery payouts. For instance, if you’ve got an IRA, you may choose to abandon a monthly payment to receive the full earnings from the retirement account. However, you’d only be able to make this decision once you reached the age of 59 1/2 (early retirement age).

The same would apply to a 401(k) retirement plan. Once you’ve reached early retirement age, you’ll have the choice between receiving a lump sum distribution, setting up an annuity or rolling your account over into another retirement account. It’s crucial to understand the difference between lump sum payments and annuities, though. We delve deeper below.

Lump Sum vs. Annuities

Whereas lump sum payments provide a single sum of money from a retirement account or life insurance policy, annuities pay back sums of money in installments over a period of time. There are generally two types of annuities: immediate annuities and deferred annuities. Immediate annuities provide ongoing monthly, quarterly or yearly payouts for a fixed period of time or for a lifetime. A deferred annuity, on the other hand, is a long-term option that allows you to invest money preretirement money that you can withdraw later in life.

For example, if you’re at least 59 1/2 and you’ve got $140,000 in an IRA, you may select an immediate annuity with a yearly payout for a fixed period of 10 years. Not including management or third-party fees, this would result in a yearly payment of roughly $14,000.

Should You Choose a Lump Sum Payment?

It’s wise to select the payment option that best aligns with your financial situation following retirement. If you’d prefer a steady stream of income during retirement, an annuity may be a suitable option.

However, if you’d like to receive your pension plan’s balance up front in a single payment, you should consider using a lump sum payment.

Bottom Line

Lump sum payments distribute account balances in a single transaction, not through regular installments. Commonly used for inheritances, pension plans and life insurance policies, these payments allow you to receive large sums of money at once. For pension plans, though, you’ll only be able to withdraw your earnings once you reach age 59 1/2. Therefore, it’s wise to choose the payment option that complements the post-employment lifestyle you’d like to live.

Retirement Savings Tips for Beginners

  • Not sure how much money you need saved to retire comfortably? Our retirement calculator can help. You’ll just need to enter your location, social security election age, annual income, monthly savings, estimated annual retirement expenses and your birth year.
  • Finding a financial advisor doesn’t have to be hard. SmartAsset’s free financial advisor matching tool connects you with up to three advisors in your area.

Photo credit: ©iStock.com/dragana991

Rickie Houston CEPF® Rickie Houston writes on a variety of personal finance topics for SmartAsset. His expertise includes retirement and banking. Rickie is a Certified Educator in Personal Finance (CEPF®). He graduated from Boston University where he received a bachelor’s degree in journalism. He’s contributed to work published in the Boston Globe and has worked alongside award-winning faculty for the New England Center of Investigative Reporting at Boston University. Rickie also enjoys playing the guitar, traveling abroad and discovering new music. He is originally from Wilmington, North Carolina.
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