Taking a lump-sum payment can be very risky. Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. In contrast, a monthly payment offers a steady income for the remainder of one's life, and in some cases can also be passed on to a spouse.
Risk That You Might Run Out of Money
Of course, one of the major pension drawdown risks is that having unfettered access to your savings can mean that you may eventually run out of money if you are not careful.
Drawdown is much more flexible than an annuity. You can change how much and when you take money out of it, and how any money you don't take out is invested. But you could run out of money because, unlike with an annuity, your payments are not guaranteed.
Take all the money out of your pension in one go
This is potentially a high-risk strategy and your pension savings were designed to provide for you throughout retirement. You could also have a high Income Tax bill to pay. If you have a large pot you could also be affected by the lump sum allowance (LSA).
Investors can avoid taxes on a lump sum pension payout by rolling over the proceeds into an individual retirement account (IRA) or other eligible retirement accounts.
As discussed below, under the right circumstances you might get more money from the lump sum payment, but that will depend on market returns and there's an element of risk to any investments. If you take the monthly pension, your payments are mostly secure and your budgeting and investing needs may be simpler.
Income drawdown can be an expensive option. There will be ongoing charges for managing your investments. Rules set by HM Revenue and Customs mean that the amount of income you take out of your pension fund has to be reviewed regularly. There are charges for this as well.
Traditionally, many have recommended the 4% rule – you should withdraw no more than 4% of your total pension pot a year. This, however, is really a maximum, and many recommend a lower percentage – the Financial Times now cites 3.5% as the maximum 1. You can also choose where this income comes from.
In general, an annuity will give you the most control over your money. If you take a lump-sum pension payment, you have the ability to use the money however you choose. For some people, it could make the most sense to use a portion of your lump sum to purchase an annuity.
This is a rule in tax law which allows investors to withdraw up to 5% of their investment into a bond, each policy year, without incurring an immediate tax charge.
Paul Squirrell. US financial planner, William P Bengen, is credited with developing the 4% rule. This states that withdrawing 4% initially from a pension pot and increasing this each year by the rate of inflation means there is little likelihood of running out of money during a 30-year period.
Drawdowns present a risk to investors in terms of how much effort or changes in prices are required to overcome them or return to the initial peak. This is why investors watch drawdown keenly and change trading strategies when things threaten to get out of hand.
You can take a flexible retirement income (drawdown)
A quarter (25%) of your pension pot can usually be taken tax-free and any other withdrawals will be taxable, whether you take them as a regular income or as lump sums. You may need to move your pension to a different provider to do this.
How much does a $300,000 annuity pay per month? As of January 2025, with a $300,000 annuity, you'll get an immediate payment of $1,800 monthly starting at age 60, $1,983 per month at age 65, or $2,138 per month at age 70.
Joint and survivor options are often best for those who are married, older than their spouse, or in poorer health than their spouse. To help mitigate premature death risks while still receiving a higher payment than joint and survivor amounts, you can also choose a single-life annuity (either term or period certain).
By retirement age, it should be 10 to 12 times your income at that time to be reasonably confident that you'll have enough funds. Seamless transition — roughly 80% of your pre-retirement income. This amount is based on a safe withdrawal rate (SWR) of about 4% of your retirement accounts each year.
How much pension do you need to live comfortably? For a quick estimate, try the '50-70' rule. This suggests that you should aim for an annual income that is between 50% and 70% of your working income.
The 4% rule is a popular retirement withdrawal strategy that suggests retirees can safely withdraw the amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years.
Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments or distributions from an employer pension, annuity, profit-sharing, stock bonus, or other deferred compensation plan.
If you have a pension fund you can take one third in cash (you'll have to pay tax and fees) and invest your two-thirds in your new company's pension/provident fund or a retirement annuity. If you have a provident fund, you can take your retirement savings as cash subject to tax.
The safe withdrawal rate helps you determine a minimum amount to withdraw in retirement to cover your basic expenses, such as rent, utilities, and food. As a rule of thumb, many retirees use 4% as their safe withdrawal rate—the so-called 4% rule.
"If the probability that you are going to live a long life is high, (the annuity) could be the benefit that gives you the most income," Ramassini says. "If your health is not great and you won't have a long life span, you may want the lump sum or joint life."
A defined benefit plan income of $30,000 annually is $2,500 per month, which is 25 times $100. Therefore, it follows that funding such a pension benefit with a 401(k)-style defined contribution plan would require retirement savings of at least $450,000 (25 × $18,000).
Under the rule, if the monthly pension offer is 6% or more than the lump sum, it makes more sense for your clients to go with the guaranteed monthly income. But if the value is less than 6%, your clients would benefit more by getting the lump sum and making smart investments.