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A lump-sum payment is a monetary sum paid in one single payment instead of allocated into installments. Lump sums are commonly associated with pension plans and other retirement vehicles, such as 401(k) accounts, where retirees might accept a smaller upfront lump-sum payment rather than a larger payment issued in installments over time.
A lump-sum payment is an amount paid all at once, as opposed to an amount that is paid in installments.
A lump-sum payment is not the best choice for everyone. For some, it may make more sense for the funds to be annuitized as periodic payments.
Based on interest rates, tax situation, and penalties, an annuity may end up having a higher net present value (NPV) than the lump-sum.
Understanding a Lump-Sum Payment
Lump-sum payments can describe a bulk payment to acquire a group of items, such as a company paying one sum for the inventory of another business. Lottery winners will also typically have the option to take a lump-sum payout versus yearly payments.
Annuities provide a degree of financial security, but an older retiree in poor health might derive greater benefit from a lump-sum payment. Securing an upfront payment often guarantees an asset to pass on to your heirs.
An upfront payment might enable you to buy a house or other large purchase that you would otherwise not be able to afford. Similarly, you can invest the money and potentially earn a higher rate of return than the effective rate of return associated with the annual payments.
The company providing the pension will calculate the commuted value of the pension to ensure they can meet their obligations.
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