Pensions are increasingly rare these days. The reason is simple: Offering pensions requires companies to make an expensive, long-term commitment to its retirees.
So it’s understandable that even companies that still provide a pension benefit are looking to reduce their costs and risks. One strategy for achieving that goal is to offer pensioners a one-time lump payment instead of a lifetime of monthly checks.
. . .
Say your pension is for $1,200 a month for life beginning at age 65. You’ve been offered a $180,000 lump sum today.
$1,200 x 12 = $14,400 divided by $180,000 equals 8%.
In this scenario, you would have to make approximately 8% per year on the $180,000 in order to earn a steady $14,400 a year.
Earning 8% a year consistently and in perpetuity is a tall order. Taking the monthly amount in this case (8% is greater than 6%) may be a better deal over the long haul.
What if you are scheduled to get $700 per month or are offered that same $180,000 buyout? Now what would you do?
$700 x 12 = $8,400 divided by $180,000 equals 4.7%.
Here, your monthly pension amount is offering you a return of just shy of 5%.
In this example, because 4.7% is less than 6%, you may be better off taking the lump sum option. Remember, for the first 20 years earning zero percent, you could do the same before you run out of money. If you made even a modest return (say, 2% per year), you would be far ahead of what the monthly pension would pay you. In this case, 4.7% is less than my bare bones benchmark of 6%, so you would probably be better off taking the lump sum of $180,000.
Take a look at these other factors worth considering if you ever face a lump sum/monthly pension option:
- Your age to begin a monthly pension vs. the lump sum.
- Your projected longevity. The longer you live, the more valuable the monthly pension amount is worth.
- The type of pension payout you elect. Is it based on your life only or are there provisions for a surviving spouse? Is there a “period certain” option that pays plan beneficiaries for a time even if you pass away soon after taking the monthly pension.
- The solvency of the company paying the pension for 20 plus years. Does the Pension Benefit Guaranty Corporation (PBGC) back up your payments if your former employer goes out of business?
- The likelihood that you’ll need a “lump sum” for a future emergency. Consider the lump sum offer in the context of your other assets.
As you can see, there are a lot of factors to consider in the lump-sum vs. monthly pension decision process. And the answer to your question is highly unique.
Take the first step and do the math to see how your offer fares under the 6% Rule; it’s where I start when helping families make this difficult choice. From there, consider the variables above to see which way the scale may tip for your individual situation.
Should You Take Your Pension in a Lump Sum or Monthly Payments?