Pension Lump Sum vs Annuity
Your employer offers a lump sum or a monthly pension for life. The way to compare them is not a gut feeling about "having control" — it is one number: the payout rate the annuity implies, and whether your portfolio could beat it.
Step one: calculate the implied payout rate
Divide the annual pension by the lump sum. A $2,000-a-month pension against a $400,000 lump sum is $24,000 ÷ $400,000 = 6%. Now compare that to what you could safely withdraw from the same money yourself — which for a 30-year horizon is roughly 4%.
| Implied payout rate | Reading |
|---|---|
| Under 4% | The lump sum is generous. Take it and invest. |
| 4% – 5% | Close. Decide on the non-financial factors below. |
| 5% – 6% | The annuity is competitive, especially if it has any inflation adjustment. |
| Over 6% | The annuity is hard to beat with a portfolio at acceptable risk. |
Set the calculator above to the lump sum and the monthly pension amount. If it says the money runs out well before 95, the annuity is paying more than your portfolio safely can.
The adjustment most people forget
Most private pensions are not inflation-adjusted. A fixed $2,000 a month is worth about $1,220 in today's money after 20 years at 2.5% inflation, and about $950 after 30. That is a serious erosion, and it is why a 6% fixed annuity is not obviously better than a 4% withdrawal from a portfolio that grows. Federal and most state government pensions do have cost-of-living adjustments, which changes the comparison completely — a COLA'd pension at 5% is exceptional value.
Take the annuity when
- The implied payout rate is above 5–6% and the pension has any inflation protection.
- You have no other guaranteed income beyond Social Security and want essentials covered for life.
- You are in good health with family longevity — annuities pay off for people who live long.
- You know you would be tempted to spend or mismanage a large lump sum.
- Your plan is well funded and covered by the Pension Benefit Guaranty Corporation within its limits.
Take the lump sum when
- The implied payout rate is below 4–4.5%.
- Your health or family history suggests a shorter horizon.
- You want to leave money to heirs — a single-life annuity pays nothing after your death.
- You already have substantial guaranteed income and want flexibility instead.
- The employer is in financial difficulty and the benefit exceeds PBGC guarantee limits.
The survivor decision inside the annuity
If you take the annuity and are married, the single-life option pays more but stops at your death. A 50% or 100% joint-and-survivor option pays less each month and continues for your spouse. Declining survivor benefits requires spousal consent for a reason — it is the choice most likely to leave a widow or widower short, and the extra monthly income rarely justifies it unless the spouse has a large pension of their own.
How the calculator works
Each month the balance earns one month of return, then the withdrawal is taken out. Every 12 months the withdrawal is increased by the inflation rate so your spending power stays level. If you enter a tax rate, each withdrawal is grossed up so the after-tax amount you keep matches the number you typed. The calculator stops when the balance hits zero, or after 100 years if it never does.
The "to last 20 / 25 / 30 years" figures are solved by bisection: the largest starting withdrawal that still survives that horizon under the same return and inflation assumptions.
Frequently asked questions
Should I take a pension lump sum or monthly payments?
Divide the annual pension by the lump sum to get the implied payout rate. Below about 4% the lump sum is generous; above about 6% the annuity is hard to beat with a portfolio. Between those, non-financial factors — health, heirs, other guaranteed income — decide it.
How do I calculate the value of a pension?
Compare it to the lump sum needed to produce the same income safely. A $2,000 monthly pension is $24,000 a year; at a 4% safe withdrawal rate that would require roughly $600,000 of portfolio. If the offered lump sum is well below that, the pension is the better value.
Does inflation matter for a pension decision?
Enormously. Most private pensions are fixed, so a $2,000 payment loses about 40% of its purchasing power over 20 years at 2.5% inflation. A government pension with a cost-of-living adjustment is worth far more than the same headline amount without one.
What happens to my pension if my employer goes bankrupt?
Private defined-benefit pensions are insured by the Pension Benefit Guaranty Corporation up to annual limits that vary with your age at retirement. Benefits above the limit are at risk, which is one of the few strong arguments for taking a lump sum from a weak sponsor.
Related calculators
SavingsLast calculators are educational estimates. They assume a constant average return and steady inflation; real markets are volatile and sequence-of-returns risk can shorten how long money lasts. Nothing here is financial, investment, tax, or legal advice. Consult a qualified professional before making decisions.