Lump Sum or Pension

Lump Sum or Pension

How to evaluate whether to take a Lump Sum or a Pension

This content was featured in an article in the Chicago Tribune on 3/15/19.

Over the last year, there have been numerous companies offering “Lump Sum” buyouts of employee pension plans. This is happening for two main reasons. First, assets in pension plans have performed fairly well given the robust nature of the equity market returns over the last 5-7 years. Secondly, employers are looking to shed themselves of these long-term pension obligations and shift the risk and cost of managing them back on the employee. This allows companies to spend their time, effort and energy managing their core business operations, and not pension plans.

That being said, there are three specific data points that need to be understood to then allow an employee to begin analyzing the appropriate decision to take the Lump Sum, or simply take the Pension payments:

Monthly Pension amount guaranteed to the employee

Lump Sum payment amount

Employee’s current and estimated retirement tax bracket

Once these three data points are obtained, simple mathematical modeling can quickly demonstrate the financial ramifications of both the Lump Sum as well as the traditional Pension. But simple math is not the only consideration when evaluating this choice.

This decision needs to be based on mathematical facts and then analyzed on many other points of personal data to arrive at the best choice for each person.

Although this mathematical modeling provides a basic financial framework for making a Lump Sum versus Pension decision, there are numerous ancillary factors that need to be taken into consideration for each employee before any final decision is made...

Lump Sum vs. Pension Considerations

Pension payout based on employee life only or joint and survivor

Pension payments can be based on the life expectancy of either the employee, or the employee and his/her spouse. As such, large age gaps between the couple, increased longevity concerns, and possible risk of loss of pension upon death of the employee all need to be reviewed. 

Diversification of retirement income streams

Employees need to review all available sources of both assets and income streams for retirement when determining whether to “Lump Sum” or not. Just as it’s important to diversify assets, it’s a good idea to consider diversifying retirement income streams as well.

Estimated portfolio returns

One of the biggest factors in determining the benefit of a “Lump Sum” payout is the estimated rate of return of the invested assets. Oftentimes, employees use an estimated rate of return far in excess of what is actually achievable. Most pension plans assume a rate of return between 4% and 6%. While it is true that over the long-term this rate can be exceeded, it is entirely on the recipient to develop, maintain, and stick with a disciplined investment strategy.

Employee health and longevity considerations

Another key consideration is employee health and longevity. Quite simply, if health is poor and/or there is little longevity concern, it is often beneficial to take the lump sum.

Guaranteed nature of pension by ERISA (up to approximately $67,295/year in 2019) 

It is often overlooked, and rarely talked about…the word GUARANTEED. If one’s pension is less than $67,295/year, it is GUARANTEED by the federal government (actually an agency of the government – ERISA). Absolutely nothing is guaranteed in the case of a lump sum, and this cannot be ignored.

Unique planning opportunities with reduced pension income

By taking a lump sum, a retiree can create unique planning opportunities by reducing their income in retirement years. This may allow a family to live on after-tax assets, creating little to no income tax ramifications, and thus potentially allowing a family to significantly reduce their lifetime effective tax rate.

Life Insurance coverage 

One common strategy for pension recipients is to opt for a reduced pension payout, which then ensures that the pension lasts for not only the life of the employee, but also for the life of his/her spouse. If a Lump Sum is chosen, the need for and the associated cost of this insurance is negated. 

Quite often, the decision to accept a traditional Pension or take the Lump Sum is based on either an emotional decision, or advice from a good friend or co-worker who has “already done the analysis”. However, as illustrated by the various key points above, this decision needs to be based on mathematical facts and then analyzed on many other points of personal data to arrive at the best choice for each person.


Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.