Lump Sum vs. Monthly Payments Discussion

Believe it or not there are still a few private sector employees that still have what would be considered a traditional pension or defined benefit plan, although this benefit is rapidly disappearing.  A pension is a plan where contributions were made on behalf of the participant during their working years and their ultimate payout is calculated using a number of factors such as years of service and salary levels.

 A common question we get when an individual is offered the choice is whether or not they should take the monthly payout option or a lump sum.  As with many choices in life there is no clear-cut answer.  “It depends” is the correct answer even though it is often met with frustration from the individual looking to make a quick and easy decision.

 There is a the quick math calculation which tells you if a lump sum of money is worth more or less than a series of lifetime payments.  This calculation will require you to make assumptions about rates of return and how long you will live in order to give you the answer you seek.  There are many online calculators available and for our purposes in this blog post we will focus on some other mitigating factors.


 The funding level of a pension measures the ability to meet future obligations.  Plans that are between 60-80% funded are only allowed to pay half of the benefit in a lump sum.  Plans that are less than 60% funded are prohibited from paying out dollars in a lump sum.  If you are being offer a lump sum less than half than the value of the benefit paid there would have to be some pretty compelling and extraordinary circumstances to opt for a lump sum.


 Monthly payments from a pension plan are a great way to meet your monthly expenses.  However, if your expenses are met through other sources you may benefit from rolling over your lump sum payment into an IRA and deferring the tax liability (monthly pension benefits are taxed as ordinary income when received) until the time when you actually need the funds.  Although there are some monthly payouts that allow a survivor benefit, if the ultimate goal is to preserve and pass to the next generation the lump sum rollover works better.


 Few pension plans adjust payments for inflation.  If your lifetime pension payment today is $1,500/month you would need $2,336.95 to buy the same level of goods and services in 15 years assuming a historical 3% annual inflation rate.  The longer you live you have no mechanism to combat inflation with a pension plan that doesn’t offer inflation adjustments.


 A lot of people know themselves and their limitations.  All things being equal some people know that if they have access to a half million dollars they would be too tempted to squander the money as opposed to only having access to a check each month.  Research shows that when given the choice an overwhelming number of pension recipients and lottery winners will choose the lump sum.  In reality there are some individuals are simply better off protecting themselves from themselves.


 Future pension obligations are on a liability on a company’s books.  So if you may want to consider the long-term financial viability of your former employer.  The Pension Guaranty Benefit Corporation is a U.S. Government Agency that insures plan benefits but only to a certain amount.  The PGBC website allows you to find out if your plan is covered.

 This is not meant to be a comprehensive list, only food for thought beyond a simple online calculator.  I often hear “my coworker retired last year and said the lump sum was what I should do.”  Please realize their circumstances could be vastly different from yours and sometimes the options available could be different as well.  Do your homework and if necessary ask for help from a reputable financial planner/advisor.


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