Should I Take a $150,000 Lump Sum or $1,200 Monthly Payments for My Pension?

Deciding between a lump sum pension and monthly payments depends on factors like life expectancy, income needs, investment preferences and inflation. A lump sum gives you immediate access to the full payout, which you can invest or use for large expenses, while monthly payments provide steady, guaranteed income for life. For example, say that you’re getting ready for retirement and your employer has offered you either a $150,000 lump sum or $1,200 monthly payments for life. The choice may come down to whether you value flexibility and potential growth or predictable income over time.

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How Do Pensions Work?

Pensions are otherwise known as “defined benefit retirement plans.” This means that your employer commits to providing certain benefits in retirement. This is as opposed to “defined contribution retirement plans,” through which your employer commits to providing certain contributions during employment.

With a pension, your employer promises to provide monthly payments throughout your retirement. The exact amount can range widely, and is typically determined by factors that include your age, salary history, tenure with the company and seniority at retirement. This amount may be indexed to inflation or, like an annuity, it might be fixed.

It is the employer’s responsibility to keep the pension funded and solvent throughout eligible former employees’ lifetimes. To ensure that this system functions, pensions are backstopped by a federal agency which insures pensions up to a maximum amount.

Managing the Costs of Pensions

Pensions are popular among workers and retirees because of their reliability. You don’t have to worry about balancing savings against costs of living. Nor do you need to manage complex, unpredictable and (if, you go it alone, very mixed) market returns. Instead, you can simply retire with an income.

For this same reason, however, pensions have become unpopular among employers. The same reliability that makes pensions valuable for retirees creates high and indefinite costs for companies. The expense of caring for a former workforce, quite simply, is very expensive.

As a result, among employers that do offer a pension, it’s common to offer “lump sum distributions.” With a lump sum distribution, the employee receives a single payout at retirement instead of monthly payments for life. This can turn an indefinite series of payments into one, scheduled expense, which is much more manageable for the employer.

Should You Take A Lump Sum or Monthly Payments?

As an employee, though, which is in your best interest?

For example, say that your employer has offered you two options. You can take $1,200 per month for the rest of your life, or you can collect a $150,000 lump sum payout. Which should you take?

The answer here depends on a lot of factors, including how the math breaks down.

Reliability

If you are seeking reliability, take the monthly payment. As discussed below, under the right circumstances you might get more money from the lump sum payment, but that will depend on market returns and there’s an element of risk to any investments. If you take the monthly pension, your payments are mostly secure and your budgeting and investing needs may be simpler.

Total Income

If, instead, you’re trying to maximize your retirement income the right choice will depend a lot on your assumptions and your projected investment outcomes.

An investor looking for safer investments, generally in the bond market, will probably make more money taking the monthly payments. However an investor who can successfully manage a more aggressive position, perhaps with a mixed portfolio or an S&P 500 index fund, will probably make more with the lump sum.

To understand this, let’s assume that you retire at age 67 and have the average life expectancy of around 85. And let’s assume that your pension is fixed, with no inflation adjustments. Using the present value formula, you would calculate that you would need a reliable return of 6.73% on your $150,000 lump sum in order to generate $1,200 in monthly payments for 18 years. If you don’t feel like you could earn more than 6.73% on your lump sum investment, you would likely opt for the monthly annuity.

But it would mean managing the volatility and risk that comes with equity investment. In particular, you would need a plan for income during down years so that sequence risk doesn’t erode the value of your portfolio. For this reason, retirees prefer to shift their investments toward security in retirement. This tends to lean toward bond-heavy portfolios, which generally issue returns between 4% and 6%. In that case, the $1,200 monthly payment would likely provide both better security and more income.

A fiduciary financial advisor can help you do the math in your personal situation. Get matched with up to three advisors for free.

Inflation

Inflation plays a key role in this decision. Some pensions include cost of living adjustments (COLAs), which increase your monthly payments over time. These adjustments may be tied to actual inflation measures or set as a flat percentage, such as 2% annually.

If your $1,200 pension payment rises 2% per year, the break-even return on the $150,000 lump sum climbs. Using common assumptions, you’d need close to a 9% annual return on the lump sum to match an inflation-indexed pension, and closer to 10% to significantly exceed it. While equities have historically delivered long-term returns in that range, relying entirely on stocks in retirement introduces volatility and sequence risk.

Without a COLA, the $1,200 remains fixed, meaning inflation erodes its purchasing power. In that case, investing a lump sum may provide more opportunity to keep pace with rising costs, though results depend on your asset allocation and actual investment performance.

A financial advisor can help you understand the implications of your employer’s specific pension plan. Talk to a financial advisor today.

Bottom Line

If your employer offers a pension, they will frequently give you two options: a lifetime of monthly payments or a lump-sum at retirement. Seek good financial advice as you choose between those two options, because the correct answer will depend a lot on your approach to investment and your personal situation.

Tips for Building a Private Pension

If your employer doesn’t offer a pension fund, you can also try to build one… sort of. Annuities are an asset that can provide a guaranteed income for life, which has led them to be called “private pensions.” There are risks to this asset class, like every other, but they can provide the kind of security of a traditional pension.
A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.