More and more companies offer pension members a one-time choice: keep your monthly pension for life, or take a single lump sum now. The offer letter usually gives you 60 to 90 days to decide, and the decision is permanent. Here is how to think it through.
How the lump sum is figured
A lump sum is your future monthly payments turned into one amount today. To do that, the plan uses two things set by IRS rules:
- Interest rates. The plan assumes your money could earn a certain return. When interest rates are high, the lump sum is smaller, because less money is needed today to produce the same payments. When rates fall, lump sums grow.
- Life expectancy. The plan uses an IRS mortality table to estimate how many years of payments you would receive.
This is why two people with the same pension can get very different offers in different years. A small change in interest rates can move a lump sum by tens of thousands of dollars.
The one number to check first
The simplest test is to ask: what return would the lump sum need to earn so I could pay myself the same monthly amount for life?
Our lump sum or monthly calculator works this out. As a rough guide:
| Return needed | What it suggests |
|---|---|
| 3% or less | The lump sum is a generous offer |
| 3% to 5.5% | A close call that depends on your situation |
| Over 5.5% | The monthly pension is likely worth more |
If the lump sum needs a high return just to match the pension, you are taking on market risk for no extra reward.
Reasons the monthly pension often wins
It lasts as long as you do. A pension keeps paying at 95 or 100. A lump sum can run out, especially if markets fall early in retirement.
It is insured. Most private pensions are covered by the Pension Benefit Guaranty Corporation up to a yearly limit. See what happens if your company’s pension fails.
It protects you from yourself. A large balance invites spending, gifts to family and expensive mistakes. A monthly check does not.
It is cheap to replace. Buying the same lifetime income from an insurance company as an annuity usually costs more than the lump sum you are offered.
Reasons a lump sum can make sense
Your health is poor. If you do not expect to live long, the lump sum may be worth more than the payments you would collect.
You have other steady income. If Social Security and other pensions already cover your basic bills, a lump sum can be invested for growth and flexibility.
You want to leave money to your family. Once you and your spouse die, most pensions stop. Whatever is left of a lump sum can go to your children.
You worry about the company. If your pension is larger than the PBGC limit and the company is weak, taking the money can remove that risk.
Your spouse has to agree
Federal law protects spouses in private pensions. If you are married, your plan’s normal payment is a joint and survivor pension that keeps paying your spouse after you die. To take a lump sum or a single-life pension instead, your spouse must sign a written consent, usually in front of a notary or plan representative.
Before you compare, make sure you are looking at the right monthly number. A joint pension pays less each month than a single-life pension, but it can be worth much more if your spouse outlives you.
Taxes: roll it over, do not cash it out
How you take the lump sum matters as much as whether you take it.
- Direct rollover to an IRA. The money moves straight from the plan to your IRA. No tax is due until you take money out later.
- Cash payment. The plan must withhold 20% for federal tax, and the whole amount counts as income that year. That can push you into a much higher tax bracket. If you are under 55 when you leave the job, or under 59½ in some cases, a 10% penalty can apply too.
Almost everyone who takes a lump sum should do a direct rollover.
Questions to ask before you decide
- What return does the lump sum need to match my pension?
- Does my spouse need the survivor protection a joint pension gives?
- Will Social Security and my other income cover my basic bills without this pension?
- Am I comfortable managing a large investment account for 25 years or more?
- Is my pension under the PBGC limit?
- What would it cost to buy the same income as an annuity?
Do not forget Social Security
A pension buyout decision often comes around the same time as the Social Security decision. A steady pension can let you wait longer to claim Social Security, which raises that check for life. Taking a lump sum and spending it first can do the same. See when to claim Social Security.
Public pensions are different
Teachers, police officers and government workers usually cannot take a lump sum for their full pension. Some plans offer a partial lump sum or a DROP account instead. If that is you, see the DROP calculator and our public pension plan pages.