Key takeaways
- Divide the annual pension by the lump sum to get a payout rate. A $30,000 pension against a $450,000 lump sum is 6.7% — far above the ~4% a portfolio safely supports.
- The catch: most private pensions have no cost-of-living increases. At 2.5% inflation, a fixed $30,000 buys about $18,300 of today's goods after 20 years.
- The survivor election is part of the price — a joint-and-survivor pension pays less each month but keeps paying a spouse.
- A lump sum must be moved by direct rollover to an IRA, or it is taxed as income with 20% withheld.
- Rough guide: a high payout rate with a survivor option favours the pension; a low payout rate, a shaky sponsor, or a strong need for flexibility and legacy favours the lump sum.
Step 1: convert the offer into a payout rate
A monthly pension and a lump sum become comparable the moment you express the pension as a percentage of the cash you are giving up:
Example: $2,500 a month is $30,000 a year. Against a $450,000 lump sum: $30,000 ÷ $450,000 = 6.7%.
Now you have something to judge. A portfolio of your own safely supports something in the region of 3.5% to 4% a year, adjusted for inflation. A 6.7% payout rate is well above that, which is a strong signal in the pension's favour before any adjustments.
| Monthly pension | Annual | Payout rate | 4% benchmark | Signal |
|---|---|---|---|---|
| $1,500 | $18,000 | 4.0% | $18,000 | Neutral — take the flexibility |
| $2,000 | $24,000 | 5.3% | $18,000 | Pension ahead on income |
| $2,500 | $30,000 | 6.7% | $18,000 | Pension well ahead |
| $3,000 | $36,000 | 8.0% | $18,000 | Pension strongly favoured |
Step 2: subtract the missing inflation increases
This is the adjustment that changes minds. The 4% benchmark is an inflation-adjusted withdrawal — it rises with prices every year. Most private-sector pensions are fixed in nominal dollars and never rise at all. (Many federal and some state plans do include increases; check yours rather than assuming.)
| Years from now | Inflation factor | Real value of $30,000 |
|---|---|---|
| 10 | 1.280 | $23,436 |
| 20 | 1.639 | $18,308 |
| 25 | 1.854 | $16,181 |
| 30 | 2.098 | $14,302 |
A 6.7% payout rate that erodes to less than half its purchasing power over a long retirement is not really 6.7%. A reasonable way to think about it: the fixed pension is generous early and thin late, while the portfolio withdrawal is level throughout. If you are 65 and healthy, the late years matter. If you are 70 with a modest life expectancy, the early years dominate and the fixed payment looks better.
Step 3: price the survivor election
Pension offers usually come in several shapes: single life (largest monthly payment, stops at your death), or joint and survivor at 50%, 75% or 100% (smaller payment, continues to a spouse). The reduction is the price of insuring your spouse's income, and choosing single life to maximise the monthly figure is one of the most consequential mistakes available in retirement planning — particularly for a household that also loses the smaller Social Security benefit when one spouse dies.
A lump sum sidesteps the question: whatever remains passes to your heirs. That legacy value is real, and it is the strongest argument for the lump sum in households where both partners already have secure income.
Step 4: weigh the risks on each side
| Risk | Monthly pension | Lump sum |
|---|---|---|
| Outliving the money | Employer's problem — paid for life | Yours — depends on withdrawal rate |
| Inflation | Yours, unless the plan has increases | Manageable — invest for real growth |
| Markets | Not your problem | Yours entirely |
| Sponsor failure | Real, though private plans are insured by the PBGC up to statutory limits | None once rolled over |
| Legacy for heirs | Nothing beyond the survivor election | Whatever is left |
| Your own decisions | Nothing to manage | You must not overspend it |
Government and church plans are generally outside PBGC coverage, and the insurance caps matter most for high earners with large accrued benefits. If your monthly amount is modest and the plan is a private one, sponsor risk is a small factor; if it is large, it deserves attention.
Step 5: do not fumble the tax
If you take the lump sum, move it by direct rollover into an IRA — trustee to trustee, never touching your bank account. Take the cheque yourself and the plan must withhold 20%, and you have 60 days to redeposit the full amount including the part they withheld. This is the same trap covered in our guide to 401(k) rollover options, and it is entirely avoidable.
Once in an IRA, the money is taxed like any other pre-tax balance: ordinary income on withdrawal, subject to required minimum distributions later. Monthly pension payments are also ordinary income, so tax treatment is broadly neutral between the two — what changes is your control over when the income lands, which is worth real money if you are also doing Roth conversions or watching an IRMAA threshold.
A workable decision rule
- Payout rate above about 6% with a survivor option — the pension is hard to beat, especially as the floor under your essential spending.
- Payout rate near 4% or below — the lump sum gives you the same income with flexibility, inflation protection and a legacy.
- Somewhere in between — decide on the softer factors: health, whether you have other guaranteed income, and how much you value not having to manage the money.
- Both, if offered. Some plans allow a partial lump sum. Covering essentials with the pension and keeping the rest liquid is often the best of both.
The annuity payout calculator shows what income a lump sum would buy on the open market — a useful reality check on whether your employer's offer is generous — and the retirement drawdown calculator tests how long the lump sum would last under your own spending.
Frequently asked questions
How do I compare a pension to a lump sum?
Divide the annual pension by the lump sum to get a payout rate, then compare it to the 3.5% to 4% a portfolio sustainably supports. Adjust downward if the pension has no cost-of-living increases, and account for the survivor election and the value of leaving money to heirs.
Is a 6% pension payout rate good?
It is well above what a portfolio safely supports, so on income alone the pension wins. The question is whether it stays ahead: a fixed payment loses roughly a third of its purchasing power in 15 years at 2.5% inflation, while a 4% portfolio withdrawal is designed to keep pace.
Should I take the lump sum and buy an annuity instead?
Sometimes worth checking. Price what your lump sum would buy in the commercial market and compare it to the employer's monthly offer. Employer pensions often quote better terms because they are not paying a commercial insurer's costs, but the comparison is quick and occasionally surprising.
How is a pension lump sum taxed?
As ordinary income if you take it in cash, with 20% mandatory withholding and a 60-day window to complete a rollover. Move it by direct trustee-to-trustee rollover into an IRA instead and nothing is taxed until you withdraw it.
What happens to my pension if my former employer goes under?
Private-sector defined benefit plans are generally insured by the Pension Benefit Guaranty Corporation up to statutory limits, so most participants would continue to be paid. Government and church plans are typically outside that coverage, and very large accrued benefits can exceed the caps.
Test the offer inside your plan
Planomy lets you model the pension and the lump sum as two scenarios side by side, with taxes, Social Security and spending included, so you can see which one leaves the household better off at 85. Free, private, and running in your browser.