According to the U.S. Department of Labor, the 1970s saw private pension plans to the tune of 103,000. By 2017, that number had dropped to 46,700. The Bureau of Labor Statistics recently reported that only 15% of private-sector workers enjoy access to a pension, in fact.

This downward trend toward extinction is set to continue. Not only are defined-contribution plans—such as 401(k)s—less expensive and less complex to manage than private pension plans, but employers also want to mitigate future pension obligations (thus reducing corresponding impacts on their financials). To accomplish this, many offer participants a lump-sum payment option in lieu of future monthly payments.

The stability of monthly payments may sound reassuring, while the lump-sum offer is perhaps simply irresistible. How can one decide? Quite frankly, this is a significant decision and one not to be taken lightly. This post will provide some education on various options, making your life a little bit easier in the process.

When a lump-sum payout may make sense

You can outperform your pension administrator’s assumptions
Your pension administrator considers various factors, including your age, life expectancy, and prevailing interest rates, when calculating the amount of your lump-sum offer. Thus, in a high-rate environment, your lump sum offer will actually be lower (note that interest rate changes have no impact on your monthly pension amount).

That said, the interest rate component of this equation is essentially the rate of return you’ll need to use as a benchmark.

Therefore, if health isn’t on your side (the longer you live beyond your life expectancy generally makes the monthly payment a better option) and you think you can outperform your pension administrator’s assumptions, meaning you can earn a higher rate of return investing on your own than the interest rate they’re using, then accepting a lump-sum offer might make the most sense.

Note that earning a higher rate of return on your own may be more realistic in a lower interest rate environment since the S&P 500 returns averaged under 7% from 2000 to 2023.

You don’t need the money
If you’re fortunate enough to enjoy sufficient sources of retirement income and are confident you won’t require monthly payments, accepting a lump-sum offer is perhaps the best option—giving you the freedom to do whatever you want with the money. Moreover, if this payment option can also help you delay claiming Social Security, this will actually boost your monthly benefit because Social Security benefits increase by approximately 7% each year between age 62 (when you’re first eligible) and your full retirement age (age 67, if you were born after 1960). After that, the increase rises to approximately 8% each year between your full retirement age and age 70.

You want to protect your legacy
Lump-sum payments allow you to leave any assets remaining at the time of your death to your children or other heirs. In contrast, a monthly pension ceases when you or a spouse pass away (depending on your plan options—more on that later), meaning you won’t be able to leave anything to heirs.

You’re in poor health
As a general rule, people in good health or with good reason to believe they or a spouse will surpass the average life expectancy may consider monthly payments the more attractive option. If you’re in poor health, don’t expect to live very long, and don’t need to worry about your spouse’s financial situation, a lump-sum payment may make the most sense.

You are worried about your employer’s financial situation
The truth is that even if your employer goes bankrupt, this likely won’t impact you much because the Pension Benefit Guaranty Corporation (PBGC)—a federal agency created to protect most private-sector pension plans—would likely replace your payments in full up to specific age-based limits. For example, their most recent guarantee for 65-year-olds is a maximum of $6,750 per month. The median private pension benefit for those aged 65+ is just over $11,000 a year.

If you have a public pension, you can also rest easy; every state guarantees some form of legal protection for public retirement benefits and can also raise taxes to address any pension-funding deficits.

If your pension lies with a religious institution, however, you may have reason to worry as these aren’t typically covered by the Pension Benefit Guaranty Corporation (which also doesn’t typically cover professional service employers, such as doctors and lawyers, that have fallen short of 25 active participants since the ERISA enactment date).

When a lump-sum payout may NOT make sense

So, when is it not prudent to take a lump-sum offer? Here are a few reasons to avoid doing so:

You’re worried about outliving your retirement savings
Retirement is expensive; the most recent Bureau of Labor Statistics (BLS) data claims retiree households (led by someone age 65+) spend almost $58,000 a year on average.

In addition, accounts such as 401(k)s fluctuate in value: meaning during economic downturns, you can deplete your nest egg more quickly than you had originally planned. This can make it more challenging to plan for expenses, especially essential costs such as those for housing and healthcare.

Alternatively, a pension is guaranteed income; you can count on the same amount every month for the rest of your life. Although most pensions don’t adjust for inflation, monthly payments can certainly provide additional peace of mind.

You’re a spender
If you’re not financially disciplined, easy access to a large sum of money is often almost impossible to ignore. Want to take a much-needed vacation? Pay for some house repairs or help your kids purchase their first home? Do it, and you’ll likely shortchange your retirement. Don’t just take our word for it! A recent MetLife study claimed that 1 in 5 people who took a lump-sum offer drained their account within five and a half years—with an additional 35% concerned funds would run out.

You’re married
Most traditional pensions offer joint and survivor options, allowing for two beneficiaries—often you and your spouse—in exchange for a reduced monthly benefit. In other words, your spouse will continue to collect a pension benefit (typically 50% or more of your benefit) even after you pass away. When you consider that women live longer than men (an average of 6-8 years, according to the World Health Organization), losing this option can potentially hurt wives the most—especially if they’ll need the money.

Other pension considerations

Keep in mind that if you don’t roll over the lump sum directly into an IRA or employer-qualified plan such as a 401(k), the money you’ll receive is taxed as ordinary income. Consequently, you could find yourself in an even higher tax bracket—and may also incur a 10% early-withdrawal tax penalty if you take the distribution before age 59½.

Your lump-sum offer is not only based on your earnings history and years of service but also current interest rates. Because the offer amount is calculated by discounting expected future payments based on their current value, your lump-sum payment amount will decline as interest rates go up.

In sum: choosing between a monthly benefit and lump-sum pension offer

As you can see, selecting either a lump-sum pension offer or monthly payments is a highly personal decision—and not always so clear-cut. Whichever decision you make, know it will likely have a significant impact on your retirement. That’s precisely why these decisions are best addressed by working with a CFP® professional who can help guide you based on your own unique situation.

Still unsure about what to do? Schedule a FREE Discovery call with one of our CFP® professionals.

FAQs

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.