Answers · Life Insurance

Should I take my pension as a lump sum or monthly payments?

Neither is automatically better. Run one number first. Divide the yearly pension by the lump sum offer, and that is the payout rate anything else has to beat. The monthly option usually wins on income per dollar. The lump sum wins on flexibility and on what is left for your family. If you are married, the survivor election matters more than either.

You are being offered the same pension twice, and only one version moves with interest rates.

One offer is your pension as a monthly stream. The other is what that stream is worth today. To get there, the plan takes your monthly benefit, assumes how long someone your age is likely to live, and discounts it back at an interest rate set by federal rules rather than by your employer.

So the offer moves and your benefit does not. Your monthly amount is locked by a formula on your service and your pay. The lump sum is locked to nothing, and when rates rise it shrinks.

Most plans reset that rate once a year on a stated date, so ask what rate is being used and when. A month either side of it can change the offer on an identical pension.

One division tells you which offer is priced better.

Take your annual pension and divide it by the lump sum. That is your payout rate, and it turns this from a feeling into a number.

Say the pension is 2,000 dollars a month, so 24,000 a year, against a lump sum of 350,000. That is about 6.9 percent of the money, every year, for life. Now find out what 350,000 would buy as an immediate income annuity at your age. If the quote is lower, your plan is paying better than the market and the lump sum has to win on something other than income. If it is higher, the plan is the one giving you a poor rate.

We have an obvious conflict here. opfinances.com is a licensed insurance agency and we sell annuities. We are not a financial advisor and we are not a fiduciary. So treat this as arithmetic rather than a recommendation. It cuts against us as often as it cuts for us. Every figure here is illustrative, and any guarantee inside a commercial contract rests on the claims paying ability of the insurer issuing it.

The pension pays a higher rate than a portfolio safely can, and the reason is not investing skill.

A common planning rule of thumb draws about 4 percent a year from an invested balance and hopes it lasts thirty years. The pension above pays considerably more, and the gap is pooling. In any large group of retirees some die early, and the payments they never collect fund the payments still arriving for the people who reach 95. Your own account cannot do that, because the only money in it is yours.

So the lump sum does not lose on income per dollar because someone would invest it badly. It loses because it has to pay you as though you might live to 100, out of a pot that ends when it ends.

The survivor election is the part you cannot take back.

Single life pays the largest check and stops on the day you die. A joint and survivor option pays less now and keeps paying a share, usually 50, 75 or 100 percent, to your spouse for life. That protection commonly costs 10 to 25 percent of your check, depending on the share and your age gap.

Under federal pension law, joint and survivor is the default for a married participant in a private employer plan, and your spouse must sign that benefit away in writing, witnessed by a notary or a plan representative. If someone hands your spouse a form and calls it paperwork, that form is the survivor benefit.

Then there is the version we could sell you. Take single life, take the bigger check, and spend the difference on life insurance covering you. It can work, but it needs you insurable at a sensible rate and the premium well below the reduction you avoided.

The catch is the asymmetry. The pension election is permanent from the day payments start and the policy is not. A term expires, a premium goes unpaid, and if the coverage ends while your spouse is still here there is nothing to go back to. Any death benefit depends on the policy staying in force and on the claims paying ability of the insurer issuing it.

A lump sum makes you the most interesting person in the room.

The day a six figure balance lands in an IRA with your name on it, you become a prospect. Not to one firm, to all of them, including us. A monthly pension is nobody's prospect, because there is nothing to charge a percentage of and nothing to convert.

That difference in incentive shapes a lot of the advice you are about to get. If you do take the lump sum, move it by direct trustee to trustee transfer rather than having a check written to you. The withholding and 60 day traps on the other route are expensive, and our page on cashing out a 401(k) covers them.

Also ask whether your plan allows a partial lump sum alongside a reduced monthly benefit. Plenty do, and it is rarely volunteered.

Which way each kind of person usually leans.

Lean toward the monthly income if you are married and your spouse would need it, if Social Security does not already cover your fixed bills, if long life runs in your family, or if you would rather not manage a large balance in your eighties.

Lean toward the lump sum if your health is poor, if nobody depends on your income, if enough other lifetime income already covers the bills, if leaving money to your children matters more than maximizing your own check, or if your benefit runs past the federal insurance limit and your old employer's finances worry you.

Neither list is a recommendation. What is true for everybody is that both choices are permanent, and the deadline is a form with a date on it.

Related

What happens to my pension if my old employer goes out of business?

A private single employer plan is insured by the Pension Benefit Guaranty Corporation up to an annual maximum that is indexed every year. At age 65 that ceiling has recently sat above 7,000 dollars a month, which covers the great majority of private pensions in full. Multiemployer union plans fall under a separate and much lower schedule. Government and church plans are not covered by the PBGC at all. Find out which kind yours is, because it changes this decision more than most people expect.

Is a pension lump sum taxable?

If you take it in hand, yes. It is ordinary income in the year you receive it, and a large one can push you into brackets you have never seen before. Moved by direct trustee to trustee transfer into an IRA, nothing is taxable that year and tax happens later as you withdraw. The difference is entirely in how it moves, not in what it is. Confirm the treatment of your own distribution with your tax professional.

Can I take the lump sum and buy my own annuity with it?

You can, and sometimes the numbers favor it, particularly where the plan converts at a poor rate. Run the division first. If a commercial quote pays less than your pension already does, you would be paying a commission for income you already had. If it pays more, the comparison is worth taking seriously. Any guarantee inside the contract you buy depends on the claims paying ability of the insurance company issuing it.

Does taking the monthly pension change when I should claim Social Security?

The two decisions belong in the same conversation, because they hit the same survivor. A pension that reduces or stops at death and a Social Security check that disappears at death compound each other on whoever is left. We wrote separately about that gap, which is the mistake most couples make with Social Security.

Where this fits.

This question sits inside a bigger one. Life Insurance walks through the whole decision rather than this one piece of it.

On Point Finances is a licensed insurance agency, not a tax, legal, or investment adviser. This page is general education, not a recommendation, and reading it does not create a client relationship.

Start with a conversation