Retiring with an Immediate Annuity

Deciding how to handle your retirement savings is as much a personal issue as it is a financial decision. You have to come up with a strategy that will allow you to enjoy spending the money you've saved without constantly worrying that you're running through it too quickly.

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Lump Sum or Immediate Annuity

When you leave your job, you must choose whether to take the money in one lump sum, leave it in a retirement account, or annuitize it - that is, buy an immediate annuity to have your account paid out to you in regular installments. You can either have your company set up an installment plan, or you can buy an annuity.

Lump Sum Distributions

If you take your retirement account in a single payment you'll owe taxes on it immediately. That's why for most people with money in a company plan, the best strategy is to take lump sum payment and roll it into an IRA, where it can continue to grow tax-deferred in a mixture of stocks and bonds. That way, you have the money in your control to invest as you want. If you have it in an account at a mutual fund or brokerage firm, once you are ready to start taking payments, you can request systematic withdrawals so the bulk of your funds can stay invested while you spend only what you need each year. If you have a traditional IRA, you pay income tax only on the part you withdraw. With the new Roth IRAs, withdrawals after age 59 1/2 are tax-free as long as the account has been open at least five years.

A potentially unattractive element of lump sum distributions is that it requires you to manage your savings for both growth and income. If the markets make you anxious or you simply find it troubling to be constantly liquidating principal to pay your expenses, the potential for better returns may not be worth it to you. To avoid spending principal, many retirees will simply put their retirement funds into bonds or a fixed-income account and attempt to live off the income. Remember that inflation will affect the value of a fixed-income portfolio.

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Another option is to annuitize a portion of your retirement savings, either by requesting installment payments directly from your company plan or by purchasing an immediate annuity with the after-tax proceeds of a lump sum distribution. If you want to start receiving payments from your plan as soon as you leave the company, the simplest option may be to ask for installment payments. Essentially, your employer uses your funds to buy an immediate annuity, guaranteeing you a fixed rate of income for the rest of your life. You only pay income taxes on the annual amount distributed from the policy. You can also buy an immediate annuity on your own with a lump sum. Before you opt for your company's plan, you should compare it with annuities that can provide you with a guaranteed income stream for life.

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