Should I Take a Lump-Sum Pension Offer?

Employee Benefits

Jun 2

Should I Take a Lump Sum Pension Offer? financial planning investment management CFP independent RIA retirement planning tax preparation financial advisor Ridgewood Bergen County NJ Poughkeepsie NY fiduciary

According to the U.S. Department of Labor, the 1970s saw private pension plans to the tune of 103,000: a number that dropped over 50% to 46,700 by 2017. Likewise, the Bureau of Labor Statistics recently reported that only 15% of private-sector workers enjoy access to a pension.

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 a lump-sum offer is perhaps simply irresistible. How can one decide? As this is a significant decision and one not to be taken lightly, this post will provide some education on various options to make your life a little bit easier in the process.

A lump-sum payout may make sense if…

You can outperform your pension administrator’s assumptions

Pensions administrators consider various factors—including age, life expectancy, and prevailing interest rates—when calculating lump-sum offer amounts. In a high-rate environment, therefore, lump sum offers are actually lower than monthly payments (note that interest rate changes have no impact on monthly pension amounts). 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 (monthly payments are generally a better option for those likely to live beyond their life expectancy) and you believe you can outperform your pension administrator’s assumptions—earning a higher rate of return investing on your own in comparison to his/her interest rate—then accepting a lump-sum offer might make the most sense.

Note that earning a higher rate of return on your own is perhaps more realistic in a lower interest rate environment as S&P 500 returns averaged almost 8% from 2000 to 2024.

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 with Social Security benefits set to increase by approximately 7% each year between age 62 (when you’re first eligible) and your full retirement age (age 67, for those born after 1960). The increase subsequently rises to approximately 8% each year between your full retirement age and age 70.

You want to protect your legacy

While lump-sum payments allow you to leave any assets remaining at the time of your death to children or other heirs, monthly pensions cease when you or a spouse pass away (depending on your plan options—more on that later) and thus give them nothing to inherit in this case.

You’re in poor health

As a general rule, people in good health and/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, however, a lump-sum payment may make the most sense.

You’re worried about your employer’s financial situation

The truth is that even if your employer goes bankrupt, this likely won’t impact you much as 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, the guarantee for 65 year olds (straight-life annuity) is a maximum of $7,431.82 per month for 2025.

Those with a public pension can also rest easy as 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 generally cover professional service employers such as doctors and lawyers with fewer than 25 employees).

A lump-sum payout may NOT make sense if…

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 $60,087 a year on average. Accounts such as 401(k)s also fluctuate in value, meaning you can deplete your nest egg more quickly than you had originally planned during economic downturns: making it more difficult 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? Or 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 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 dry at some point.

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 longer in fact, according to the World Health Organization), losing this option can potentially hurt wives the most—especially those who will need the money.

Other pension considerations

Keep in mind that if you don’t roll over a lump sum directly into an IRA or employer-qualified plan such as a 401(k), the money received 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.

Not only based on your earnings history and years of service, lump-sum offers are also impacted by current interest rates. Because the offer amount is calculated by discounting expected future payments based on their current value, lump-sum payment amounts 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 have questions about pension payout options? Schedule a FREE discovery call with one of our CFP® professionals to get them answered!

FAQs

The Pension Benefit Guaranty Corporation (PBGC) plays a crucial role in safeguarding pension plans should an employer experience financial distress. This federal agency is responsible for insuring private-sector pension plans and will step in to provide coverage/protection for participant pensions if an employer terminates a plan due to financial difficulties. It’s important to note, however, that not all retirement plans are insured by the PBGC (so be sure to verify if the agency protects your specific plan).
Yes, this action indeed poses a significant risk as you can very well deplete your funds in this manner. As life expectancies continue to rise, retirees face the very real possibility of outliving their savings—especially if they choose to spend it all at once. Several studies likewise indicate that those who decide to cash out their pensions are less likely to maintain the same financial stability they once had within just five years’ time. On the other hand, opting for monthly payments provides a steady stream of income for the duration of one's life; the risk of running out of money is thus significantly higher when an individual decides to cash out early.
Though each entity has its own unique reasons for offering a lump-sum pension option, the most common is to shed expenses from its books. Pensions aren’t cheap, after all, and include the overall value of this in addition to administrative expenses and insurance premiums that must be paid for plans.