An annuity lump sum allows you to exchange the prospect of a regular annuity payment for a single lump sum payment. There are different pros and cons to such a form of distribution, and no one method will be right for everyone. One must consider a variety of factors when deciding whether this method is right for them.
Pros
You will be able to use the funds for immediate expenses
An annuity lump sum may be ideal for someone who has the need for a great deal of money right away. For instance, if someone has a major amount of debt, and they are paying off a lot of interest, then they may choose to turn their annuity into a lump sum so that they can pay off their debts and save the money they would otherwise have been lost on interest. If they want to make a large purchase such as if they want to buy a house, then someone may want this lump sum. It gives one the freedom to spend the money as they want.
It will allow you to invest and possibly multiply the funds
You will be able to invest the lump sum yourself and possibly earn more overall than you would receive from the annuity distributions. This is especially ideal for someone who has a lot of good investment opportunities or a lot of knowledge in investments. They may be able to invest it in such a lucrative way that they can keep the lump sum and get payments in interest, dividends or other returns as a constant payment much like the annuity would have been.
Cons
You may spend it all right away
Even those who feel that they are responsible with money will still sometimes spend more than they should. When the money is there, it is tempting to spend it. Even small costs can add up, and before you know it the annuity may be gone. People may be counting on the money for their retirement and other major expenses, and its loss can have a major effect on their lives. It may even necessitate further income.
If they had kept the distributions of the annuity, however, then the money would have been there. No matter how much they spent at a given time, they could have counted on this money coming in to aid them. They could have set it aside for a specific cause such as their mortgage or rent payments. This would assure that the money would always be there for that.
Investments may fall through
A lot of people take the lump sum distribution of annuities because they are certain they can invest it and make more money. Even seasoned investors can run into problems, however, especially in a tumultuous economy. The risk on an annuity may be little to nothing, whereas other investments can carry much more risk. Even fairly safe investments can sometimes fall through, and then you will be without the money.
Taxes may be high
With the lump sum distribution you may have to pay all of the taxes at once. How exactly this works may depend on the year in which you were born. Funds may be subject to higher income tax if you have a lot of income now. This will penalize you more since you will not be able to defer the taxes any longer and also because you may be making more now than you will in the future if you go into retirement.
Choosing an annuity lump sum can be a smart or ill-advised decision, depending on the financial situation of the investor as well as his or her threshold for risk. One should consider the exact terms of the annuity when deciding whether a lump sum is right for them.
Resources:
http://www.bankrate.com/finance/retirement/making-the-pension-decision.aspx
http://money.cnn.com/2007/01/29/pf/expert/expert.moneymag/index.htm