During a 2020 sales slump, Honda offered early retirement to some of its U.S. workers 55 and older. Those who accepted were given a choice: Either stay with the pension they’d earned — meaning they’d receive monthly payments for the rest of their lives — or walk away with a single, large payment calculated to be a fair approximation of such a pension. Many employees jumped at the prospect of taking a pile of cash, says Tom McCarthy, a financial adviser in Marysville, Ohio. “We saw a flood of associates opting to retire.”
The pension-versus-lump-sum decision leaves retirees with a conundrum: Who should manage your pension money, your old employer or you? It’s a potentially life-changing decision, says Ric Edelman, a Fairfax, Virginia, financial adviser and founder of Edelman Financial Engines. It’s also one often made hastily, as employees are frequently not given much time to decide, and many don’t have objective financial advice readily available. Once made, the decision is typically irrevocable.
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And the right choice may not be obvious. If you take a lump sum — available to about a quarter of private-industry employees covered by a pension — you run the risk of running out of money during retirement. But if you choose monthly payments and you die unexpectedly early, you and your heirs will have received far less than the lump-sum alternative. “Two people in very similar situations may opt for different outcomes,” Edelman says.
Getting to yes or no
Deciding whether a lump sum or a pension will turn out to be the better value for you personally is a complicated math problem with variables you can’t predict — chiefly, how long you’ll live (and how long your spouse will live, if you’re married), and the money you might earn by investing a lump sum. Your employer should explain how its offer was calculated. If you question the assumptions, an online calculator can estimate the investment returns you would need on your lump sum to match the value of the pension.
But such a calculator can’t take into account an uncertainty like the devastating risk of a collapsing stock market soon after you retire. “It doesn’t make sense to plug in a couple of numbers and make a critical life decision [based] on it,” says Ron Guay, a financial adviser with Garrett Investment Advisors in Sunnyvale, California.
FAQs
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. People who take a lump sum may outlive the payment, while traditional pension payments continue until death.
How do I choose between lump sum and pension? ›
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. People who take a lump sum may outlive the payment, while traditional pension payments continue until death.
What is the 6% rule for pension buyouts? ›
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.
Should I take a higher lump sum or pension? ›
Taking lump sums will affect your future contributions
If you think you might want to top up your pension pot in the future, for instance because you want to keep working part time, then you need to be aware that taking money out in lump sums could affect the amount you can pay in and receive tax relief on.
How do you evaluate a lump sum pension payout? ›
Many factors determine your lump -sum payment amount including your age, years of work, your earnings history, taxes withheld, and the terms of your plan. Take a look at your most recent pension statement, and verify that the information used to calculate your lump sum matches.
What is the best pension payout option for married couple? ›
Many married couples choose the joint life pension payout so a payment will continue to your spouse upon your death. The advantage of the joint life pension payout is that upon your death, your spouse will continue to receive a percentage of your benefit for as long as your spouse lives.
Why can't I take all my pension as a lump sum? ›
Taking too much from your pension at once could leave you with a large tax bill. It is important to remember that most withdrawals from a pension count as income, and this income is taxed in the same way as a salary. Find out more about how pension income is taxed.
What is the golden rule for pensions? ›
With the golden rule, the ratio between your coordinated wage and the projected old-age pension at the time of ordinary retirement always remains the same, regardless of whether the rates are 1% or 2%. The golden rule is essential for calculating the appropriateness of pension plans.
What is the rule of thumb for pension buyout? ›
As a general guide, you can use the 6% Rule when evaluating the two options. It's a straightforward tool to help assess which choice makes more financial sense over time. Here's how the 6% Rule works: If your monthly pension offer is 6% or more of the lump sum, it might make sense to go with the guaranteed pension.
What is a typical pension payout? ›
Median Pension Benefit
In 2022, one out of three older adults received income from private company or union pension plans, federal, state, or local government pension plans, or Railroad Retirement, military or veterans pensions. The median private pension benefit of individuals age 65 and older was $11,040 a year.
Multipliers are sometimes known by other terms, such as “accrual rate” or “crediting rate” but they mean the same thing. A typical multiplier is 2%. So, if you work 30 years, and your final average salary is $75,000, then your pension would be 30 x 2% x $75,000 = $45,000 a year.
How long is pension paid after death? ›
That depends. Some pensions end at death, meaning that no beneficiary or family member gets to claim the pension. But other pensions provide for payments to a surviving spouse or dependent children—for a few years for some, and longer for others.
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.
Do I have to pay taxes on a lump sum pension payout? ›
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.
What percentage of my pension is the lump sum? ›
In most schemes you can take 25 per cent of your pension pot as a tax-free lump sum. You'll then have 6 months to start taking the remaining 75 per cent - you can usually: get regular payments (an 'annuity') invest the money in a fund that lets you make withdrawals ('drawdown')
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.
Why do lottery winners choose lump sum? ›
Lump sum payments can also help winners avoid long-term income tax implications. However, those who elect to receive their winnings in annuity payments, or payments that are divided and issued over a fixed period of time, can end up with more in the long run.
