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What is the difference between an annuity and a lump sum?

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An annuity pays out periodic amounts to an individual until the contract ends, while a lump sum refers to a one-time payout to a person as the contract stipulates, notes David Ingram for The Nest. Investors assess economic environments and consequences of annuities and lump sums before deciding on the best option.

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Both annuities and lump-sum payouts are common in contests, compensation contracts and investments, according to Ingram. Lottery winners and other people who are unable to manage their money properly choose to invest in annuities because payments are spread out over a long period. In most cases, professional athletes receive payments in form of annuities. While the periodic payments are being made, interest on the outstanding balance continues to grow.

Unlike annuities, lump-sum payouts, including debt settlements and holiday bonus pay, may make recipients save, invest or spend the entire payment as they see fit, states Ingram. Such payments are good for shrewd investors. However, some people may find it difficult to manage the entire amount at once, ending up wasting the whole amount.

Investors use the time value of money theory, which indicates the value of money changes with time, to decide the best form of payment between annuities and lump sums, explains Ingram. Economic factors, including currency exchange rates and inflation, affect the value of money.

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