Should I Take a $200,000 Lump Sum or $1,850 Monthly Payments for My Pension?

If you have a pension, your employer will usually give you a choice at retirement: buyout or payments. It’s important to review this carefully.

In broad terms, many make this choice based on expected lifetime returns. If you take and invest the buyout, what can you reasonably expect in portfolio returns? How will that expectation compare with your guaranteed income if you take the monthly payments?

For example, take an individual at 65. They have earned a pension of $1,850 per month in retirement, but their employer has offered a $200,000 buyout at the start of their retirement instead. Here’s how to look at the issue.

Pensions are a form of employer-sponsored retirement plan. They are otherwise known as a “guaranteed benefit” retirement. 

With a pension, upon retirement you receive a series of fixed payments for life from your employer. Typically, these are issued on a monthly basis. You pay income taxes on this money, as you would with ordinary income. These payments are considered part of the compensation that you earn during your working life, meaning that your employer cannot legally adjust them after the fact. The only way to stop making these payments is through insolvency, in which case a federal agency known as the Pension Benefit Guaranty Corporation insures your payments up to a maximum amount. 

In the mid-20th century pensions were a major form of employer-issued retirement. This was in part due to the strength of union bargaining in that era, as workers tend to prefer the ease and security of a pension plan. Today they are overwhelmingly disfavored by private employers due to their significant and open-ended cost. A pension plan means that employers pay not only for their current but also their former employees, for as long as they all shall live, which gets expensive quickly.

As a result, among private employers that offer a pension plan, many have begun offering a buyout option. At retirement, you can make a choice. You either take your pension as-is and receive payments for life or you accept a single, up-front payment at retirement. 

The big question for a retiree is, should you take the buyout? The answer will depend on what you want to achieve and how you can expect to compare returns.

From an achievement standpoint, there are broadly two ways to analyze this issue: 

• Lifestyle – Which approach will generate the most reliable income in retirement?
• Net Wealth – Which approach will leave you with the most assets in total?

A net wealth approach is usually an estate planning measure. Basically, if you don’t necessarily need this as income, what gives you the most wealth to pass on to your heirs?

A lifestyle approach is the most common, and is oriented around retirement income. Basically, if you will rely on this money for income, what gives you the highest standard of living?

From there, the question is how you will manage your investments and what kind of life span you should plan for in retirement. Very broadly, you will need three figures:

• Portfolio returns
• Life expectancy
• Cost of living adjustment (COLA)

The last is a feature of some pensions, in which they increase annually to account for inflation. You’ll also want to consider less tangible inputs, such as your ability to manage money and a budget, as well as an investment portfolio.

Once you decide on your goals, the next step is to look at potential returns. If you are taking a wealth-oriented focus, the math is:

• Pension Accumulation vs. Portfolio Accumulation

If you invest your monthly income, will it grow more than if you invest the buyout? Which approach will leave more in your estate? 

Here, for example, we have either an $1,850 monthly payment or a $200,000 buyout. Let’s assume that you invest that money in an S&P 500 fund for growth, with the market’s average 10% annual return, and have no COLA. Based on SmartAsset’s investment growth calculator, if you retire at 67 and live to age 87, on the high end of average for a retiree, you might expect a final portfolio of:

• Buyout – $1.34 million
• Pension – $1.40 million 

Over 20 years, you would have more in savings from the monthly pension. On the other hand, let’s assume a younger life span, say from age 67 to 77. Your final portfolio might be:

• Buyout – $518,748
• Pension – $379,234

If you have reason to expect a retirement life span of just 10 years, your monthly payments don’t have enough time to catch up with the buyout. You will likely leave a larger estate with the buyout.

Most households will make their plans around income. If you have a pension plan, it’s likely that you will live on this and Social Security benefits. In that case, the math gets a little more complicated:

Based on how you choose to invest, and your overall life expectancy, will you make more money each month from the pension payments or from your portfolio withdrawals? This issue introduces several more areas for assumption, because you aren’t just investing for long-term growth. You’re investing for a mix of growth and security, while also taking withdrawals. 

So the question is, what rate of return would you need for your portfolio income to beat your pension income? Let’s run this for a couple of different assumptions using Schwab’s calculator:

1. Life Span 20 Years, COLA 2%: ROI 12%
   At retirement age, the average life expectancy is between 84 and 87 years old. So, if we assume that you collect your pension for 20 years, and that pension has a 2% annual cost of living adjustment, your $200,000 portfolio would need a 12% annual return to generate more than $1,850 per month of income.
2. Life Span 20 Years, COLA 0%: ROI 10%
   Here we assume the same average life span of 20 years (age 67 to age 87), but with no cost of living adjustment. In that case, your $200,000 buyout would need a 10% rate of return to generate more than $1,850 per month of income.
3. Life Span 10 Years, COLA 2%: ROI 4%
   But let’s assume you have reason to believe you will die relatively young for a retiree. With a 2% costs of living increase, but a 10 year lifespan, you will only need a 4% return for your portfolio to generate at least $1,850 per month.
4. Life Span 10 Years, COLA 0%: ROI 2.17%
   Finally, say that you have reason to believe you will die relatively young and your pension has no cost of living increase. In that case, a 2.17% rate of return will generate $1,850 per month of income. 

The upshot here is that life expectancy is largely determinative. The longer you live, the more your monthly payments will accumulate relative to your large, up-front buyout.

At age 67, the average lifespan extends into your mid-80’s. This depends significantly on gender and health, but an average retiree should expect to live between 16 and 20 more years. An even modestly long lifespan means living for more than 20 years on your savings. In that case, the pension would be significantly more valuable than the buyout. Your portfolio would need consistent, market-beating returns just to meet the pension’s income. 

On the other hand, if you have reason to believe that you will die relatively young compared with other retirees, the buyout becomes more valuable. For someone who lives only into their mid-70’s, even a bond portfolio will likely generate more income than the pension.

Should you take a buyout? That depends on a lot of assumptions and details, but very broadly speaking you are usually better off taking a monthly pension payment unless you have reason to believe that you have an unusually short life expectancy.

• Retirement investing is complicated, and that includes lump-sum investing. If you have a windfall, like a pension buyout, here’s how to think about managing it. 
• 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 up to three 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.
• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

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