Lump-Sum vs. Regular Pension Payments: What's the Difference? (2024)

If you are approaching retirement and you are receiving a pension,you may wonder if you should you accept the traditional, lifetime monthly payments or take a lump-sum distribution.

You might be tempted to go with the lump sum for the large single disbursement of money. However, before you make a decision about your financial future, learn how they compare. Each payment strategy has difference financial consequences. Let's look at the pros and cons of taking a lump sum versus a regular pension payment.

Key Takeaways

  • Pension payments are made for the rest of your life, no matter how long you live.
  • Lump-sum payments allow you to immediately spend or invest your pension as you like.
  • Studies show that retirees with monthly pension income are more likely to maintain their spending levels than those who take lump-sum distributions.
  • People who take a lump sum may outlive the payment, while traditional pension payments continue until death.
  • If a pension administrator goes bankrupt, pension payments could stop, though PBGC insurance covers most people.

Lump-Sum Payments

A lump-sum distribution of a pension is a one-time payment from your pension administrator. By taking a lump sum payment, you gain access to a large sum of money, which you can spend or invest as you see fit.

"One thing I emphasize with clients is the flexibility that comes with a lump sum payment," says Dan Danford, CFP, Family Investment Center of Saint Joseph, Missouri. A pension payment annuity "is fixed (occasionally COLA-indexed), so there is little flexibility in the payment scheme. But a 30-year retirement probably faces some surprise expenses, possibly large. The lump sum, invested properly, offers flexibility to meet those needs and can be invested to provide regular income, too."

They type of your pension payment may affect your children, as well. Consider whether you want to leave something to your loved ones after your death. Once you and your spouse die, the pension payments might stop. On the other hand, with a lump-sum distribution, you could name a beneficiary to receive any money that is left after you and your spouse are gone.

Rolling over a lump sum

Income from pensions is taxable. However, if you roll over that lump sum into your IRA, you will have much more control over it when you remove the funds and pay the income tax on them.Of course, you will eventually have to take the required minimum distributions (RMDs) from your IRA, but that won’t happen until age 73.

"Rolling your pension into an IRA will give you more options," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, MA. "It will give you more flexibility of investments that you can invest in. It will allow you to take distributions according to your required minimum distribution (RMD), which in many cases, would be lower than your planned pension payments."

Rolling a lump sum pension payment into an IRA will allow you to plan when you take your distributions. Thus you can plan when and how much you want to pay in taxes.

Regular Pension Payments

A regular pension payment is a set monthly payment payable to a retiree for life and, in some cases, for the life of a surviving spouse. Some pensions include cost-of-living adjustments (COLA), meaning payments go up over time, usually indexed to inflation.

Some argue that the main feature people like about lump-sum payments—flexibility—is a reason to avoid them because it can encourage overspending. With a regular pension checks, you don't immediately have access to a large sum of money.

A 2020 report by the Consumer Financial Protection Bureau found that retirees with pension income were more likely to remain financially stable than those who had cashed out the lump sum. Of those with regular payments, 73% could maintain the same spending levels after five years, compared to only 56% of those who had chosen the lump sum.

A lump sum also requires careful asset management. If you put the money into conservative investments so you don't lose money, the growth may not keep pace with inflation. However, if you invest in assets that can yield greater returns, you have a higher risk of losses.

With a lump sum, there is no guarantee the money will last a lifetime. A regular pension payment will last until you die.

"In an environment with low fixed-income interest rates and generally expanding life expectancies, the pension stream is generally the better way to go," says Louis Kokernak CFA, CFP, founder of Haven Financial Advisors, Austin, TX. "It is no accident that private and public employers are paring back those benefits. They are trying to save money."

You also need to think about health insurance. In some cases, company-sponsored coverage stops if an employee takes the lump sum payout. If this is the case with your employer, you will need to include the extra cost of health insurance or a Medicare health supplement in your calculations.

Risks of regular pension payments vs. lump sum

One downside of pensions is that an employer could go bankrupt and find itself unable to pay retirees. If your company is in a volatile sector or has financial troubles, it may be worth taking a lump sum. But for most individuals, these are unlikely scenarios. If you have a pension plan, you should also know that it is risky to take a loan from your plan and will probably cost you more in the long term.

Keep in mind, though, that your pension benefits are safeguarded by the Pension Benefit Guaranty Corporation (PBGC), the government entity that collects insurance premiums from employers sponsoring insuredpension plans. The PBGC only covers defined-benefit plans, not defined-contribution plans like 401(k)s.

The maximum pension benefit guaranteed by the PBGC is set by law and adjusted yearly. In 2023, the maximum annual benefit is $81,000 for a straight-life annuity for a 65-year-old retiree. (The guarantee is lower for those who retire early or if the plan involves a benefit for a survivor. It is also higher for those who retire after age 65.)

As long as your pension is less than the guarantee, you can be reasonably sure your income will continue if the company goes bankrupt.

Special Considerations

Think about why your company would want to you to cash out of your pension plan. Employers have various reasons.They may use it as an incentive for older, higher-cost workers to retire early. Or they may make the offer because eliminating pension payments generates accounting gains that boost corporate income.

Furthermore, if you take the lump sum, your company will not have to pay the administrative expenses and insurance premiums on your plan.

Before choosing between a lump sum or regular pension payments, consider how companies determine the amount of lump-sum payouts.

From an actuarial standpoint, the typical recipient would receive approximately the same amount of money whether choosing the pension or the lump sum. The pension administrator calculates the commuted value using the average lifespan of retirees and adjusts the payment schedule accordingly.

That means if you enjoy a longer-than-average life, you will probably receive more money taking the lifetime payments. But if you do not expect to live as long, you may get more with the lump sum.

One approach might be to have it both ways. You could put part of a lump sum into a fixed annuity, which provides a lifetime stream of income, and invest the remainder. But if you’d rather not worry about how the market is performing, a stable pension payment might better suited for you.

What Are the Advantages of Taking a Lump Sum on Your Pension?

A lump sum pension distribution give you your entire pension at once. It offers the flexibility of being able to spend or invest your retirement savings any way you see fit. While a pension annuity offers a fixed monthly income, a lump sum can be used for a range of purposes, including for unexpected medical expenses. If you die early, you can potentially receive more money than you would with regular payments. If invested carefully, a lump sum could also offer a passive income.

What Are the Disadvantages of Taking a Lump Sum on Your Pension?

Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. With life expectancies rising, many retirees face the increasing likelihood that they may outlive their savings, especially if they spend it. Studies show that retirees who cash out their pensions are less likely to maintain the same levels of financial stability after five years. A monthly payment offers a steady income for the remainder of one's life, and in some cases can also be passed on to a spouse.

What Happens to a Pension If Your Employer Goes Bankrupt?

If an employer goes bankrupt, they may be unable to meet their pension obligations. This is rare, but the risk is higher for companies in volatile sectors. If an employer terminates a plan due to financial distress, their pension is generally covered by the Pension Benefit Guaranty Corporation, a federal agency that insures private-sector pension plans. Not all retirement plans are insured by this agency, so it is worth checking to see if your plan is protected.

The Bottom Line

For some, a lump-sum pension payment makes sense. For others, having less to upfront capital is better. In either case, pension payments should align with your personal goals for your retirement. If you're not sure which option is best for you, consider speaking with a financial advisor to see whether a lump-sum or regular payment schedule is the best strategy for you.

Lump-Sum vs. Regular Pension Payments: What's the Difference? (2024)

FAQs

Lump-Sum vs. Regular Pension Payments: What's the Difference? ›

Pension payments are made for the rest of your life, no matter how long you live. Lump-sum payments allow you to immediately spend or invest your pension as you like. People who take a lump sum may outlive the payment, while traditional pension payments continue until death.

Is it better to take a lump sum pension or monthly payments? ›

In most cases, the lump-sum option is clearly the way to go. The main difference between a lump-sum and a monthly payment is that with a lump-sum option, you get to have control over how your money is invested and what happens to it once you're gone. If that's the case, then the lump-sum option is your best bet.

What is the 6% rule for lump sum pension? ›

To determine this number, consider the 6% rule: which states that if your monthly pension offer is 6% or more of the lump sum offer, you should choose the perpetual monthly payment option. If the number falls below 6%, you might do as well (or better) by taking the lump sum and investing it yourself.

How much tax will I pay on my lump sum pension? ›

Mandatory income tax withholding of 20% applies to most taxable distributions paid directly to you in a lump sum from employer retirement plans even if you plan to roll over the taxable amount within 60 days. Note that the default rate of withholding may be too low for your tax situation.

Should I take a lump sum pension buyout? ›

Whether you should take a pension buyout depends on when it's offered to you and your life expectancy, among many other factors. For most pensions, the earlier your employer offers the buyout, the better a deal it can be. But the closer you are to retirement age, the more you may want to prioritize monthly payments.

What is the downside lump sum pension? ›

You have to actively manage your pension amount. There is a large up-front cash drain to pay income taxes on the entire distribution if it is not rolled over to a traditional IRA or other eligible plan.

Should I take a $44000 lump sum or keep a $423 monthly pension? ›

Steve Vernon, a former pension actuary, advises people to keep a pension if they lack enough guaranteed income from other sources, including Social Security, to cover such basic expenses as food and housing.

How much is a $3000 per month pension worth? ›

I estimate that you'd be offered $470,000 for a $3,000 monthly pension that is about to start at age 65. (I can only estimate because plans vary in how quickly they adopt interest rate updates.) If you are a 65-year-old nonsmoking female, the pension is worth more like $626,000.

What is a typical pension payout? ›

Median Pension Benefit

The median private pension benefit of individuals age 65 and older was $11,040 a year. The median state or local government pension benefit was $24,980 a year. For More Statistics on the Income of Older Adults: Income of Older Adults from All Sources.

How much is the average pension in the US? ›

Retirement Income Varies Widely By State
StateAverage Retirement Income
California$34,737
Colorado$32,379
Connecticut$32,052
Delaware$31,283
47 more rows
Oct 30, 2023

How do I avoid paying taxes on my lump sum pension? ›

Investors can avoid taxes on a lump sum pension payout by rolling over the proceeds into an individual retirement account (IRA) or other eligible retirement accounts.

Does a lump sum pension affect Social Security? ›

Any reduction would be to your Social Security benefit, not your CalPERS pension. If you choose to take a refund of your CalPERS retirement contributions in a lump sum, Social Security will still calculate the reduction as if you had chosen to receive monthly payments for your government pension.

Can you collect a pension and Social Security at the same time? ›

Can you collect Social Security and a pension at the same time? You can retire with Social Security and a pension at the same time, but the Social Security Administration (SSA) might reduce your Social Security benefit if your pension is from a job at which you did not pay Social Security taxes on your wages.

Can I withdraw all my pension as a lump sum? ›

You can take your whole pension pot as cash straight away if you want to, no matter what size it is. You can also take smaller sums as cash whenever you need to. 25% of your total pension pot will be tax-free. You'll pay tax on the rest as if it were income.

How long will my pension last? ›

The State Pension is guaranteed for life. You might also be due pension income from a former employer if you were in a defined benefit pension scheme. This will provide you with a regular income for life. You might have contributed to an employer or private pension scheme where you built up your own pension pot.

How long does it take to receive lump sum pension? ›

How long does it take to receive a pension lump sum? Usually it will take around four to five weeks from the date of your request for your pension provider to release your lump sum.

How much will my Social Security be reduced if I have a pension? ›

Windfall elimination provision

The WEP may apply if you receive both a pension and Social Security benefits. In that case, the WEP can reduce your Social Security payments by up to 50% of your pension amount.

Why a pension lump sum option is better than an annuity payment? ›

If the market struggles, your annuity payments will remain the same and your company will likely to be required to make greater contributions to the pension plan to compensate for lower than expected investment returns. If you take a lump sum, no one is responsible for taking care of your money other than you.

Do lump sum payments reduce monthly payments? ›

Making a lump sum payment not only reduces the total interest you pay but also speeds up your journey to a debt-free life. With each extra payment, more of your money goes toward reducing the principal, which, in turn, reduces the overall amortization.

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