Pension Lump Sum vs Monthly Payments: How to Decide
How to compare a pension lump sum against lifetime monthly payments using present value, longevity, and your other guaranteed income.
A lump sum gives control and flexibility but shifts investment and longevity risk to you. Monthly payments give guaranteed lifetime income but usually no inflation adjustment and nothing left for heirs.
What each option is
The lump sum is a one-time distribution you typically roll into an IRA and invest yourself. The monthly option is a lifetime annuity paid by the plan (or by an insurer the plan buys the annuity from). Once you elect, the choice is generally irrevocable.
Compare with present value
Discount the stream of monthly payments back to today's dollars at a reasonable rate and compare that present value to the lump sum offer. Equivalently, divide 12 months of pension payments by the lump sum to get an implied annual payout rate. The higher the implied payout rate, the better the monthly option looks relative to what you could safely withdraw from the lump sum.
Longevity and health
Monthly payments are worth more the longer you live, because the lifetime stream keeps paying. Poor health or a family history of short longevity tilts toward the lump sum. Excellent health and long-lived parents tilts toward the monthly.
Inflation and survivors
Most private pensions are not adjusted for inflation, so a fixed monthly payment loses purchasing power every year. A joint-and-survivor election lowers the monthly amount but continues part or all of it to a surviving spouse; a single-life election pays the most but stops at death.
Worked example
A 300,000 dollar lump sum vs a 1,800 dollar monthly single-life pension implies a 7.2 percent annual payout rate on the lump sum, well above a 4 percent safe withdrawal rate. In this case the monthly wins at any reasonable life expectancy, especially for a healthy retiree.
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