Lump Sum distributions can allow you to invest according to your preferences, but could also be used frivolously and spent down in a short time.
The first thing to keep in mind is that it’s very easy to spend a lump sum right away without thinking about the consequences. While the monthly payment option protects your money from overspending, many people feel that they would derive a greater value from having access to more of their money.
This could potentially be the case, but people often underestimate how much value there can be in a lifetime income annuity. Retirees experience psychological benefits as well as financial benefits by knowing that they have a certain income guaranteed for life. A lump sum should be handled with frugality and practicality. A large portion of this amount should be invested safely and wisely.
When you are ready to draw income out of it, you need to research a wise income strategy and attempt to stick to it. This may mean only spending gains and dividends, or sticking to a safe withdrawal rate. Safe withdrawal rates are estimations of what percentage of an investment account you can withdraw a year and have your money last through retirement. (To learn more about spending dividends, see “What is Dividend Adjusted Return?”
When interest rates are low, the safe withdrawal rate is a little lower as well. Today income experts estimate that about 4%, but even as low as 3%, is the safe withdrawal rate based on the current risk-adjusted return that retirees can expect. Most retirees are unwilling to use enough self-discipline to keep withdrawals around the safe withdrawal rate.
This can be a terrible mistake when healthcare costs and the effects of inflation start to take their toll on the retiree’s nest egg. People are living longer today than ever before, and you may have to try to make your money last for 40 years or more. Lifetime income starts to sound better and better, especially when they can guarantee withdrawal rates around 7% and up for as long as you live.
What is a Lump-Sum Distribution from a 401(k)?
Can I Take a Lump-Sum Distribution From My Pension Plan?
What role does inflation play in my retirement planning?