Deciding whether to take a $400,000 lump sum or monthly pension benefit of $2,000 requires calculating the relative value of each option. Generally speaking, the sooner you can receive the lump sum, the more value it will have since you can invest it over a longer period. The monthly payment option may be more valuable if you expect to live a long time after you start receiving benefits. Other factors include inflation, your additional sources of income and how prudently you can manage a large sum of money. A major financial decision like choosing between a lump sum or monthly payout can benefit from the assistance of a financial advisor.
Sometimes companies with pension plans offer current and future retirees the option of receiving a large one-time payment instead of a series of smaller payments usually administered on a monthly basis. These buyouts represent a way for companies to manage their risk while also offering some potential advantages to retirees.
Deciding whether or not to accept a lump sum offer involves evaluating a number of factors. Some of these – such as the dollar amount of the lump sum or the monthly benefit – are clearly specified up front. For other key variables, such as the investment returns that can be expected or future inflation, the assessment has to rely on educated guesses about future developments.
Two of the most critical variables are when the lump sum will be paid and how long the employee expects to live. Generally speaking, the sooner the lump sum will be paid, the more value that choice assumes. Similarly, the longer the beneficiary expects to live, the more valuable the stream of payments is.
Some of the factors that need to be assessed include the beneficiary’s current health, the age at which their parents died and the typical lifespan that can be expected by someone of their age and gender.
Other individual circumstances can also tilt the scales. For example, someone with a lot of high-interest debt might be better off with a lump sum that would let them pay off their loans. On the other hand, someone who is not confident in their ability to prudently handle a large sum of money might find the monthly payments to be the safer choice.
If you’re faced with the choice between receiving a lump sum or monthly payments from a pension or annuity, a financial advisor can help you weigh your options.
An elderly man calculates how much income his lump some pension payment may generate for him.
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If you were faced with the choice between a $400,000 lump sum or $2,000 per month for the rest of your life, what would you do?
Let’s assume that you’re currently 60 and can receive the lump sum immediately. Alternatively, you could start receiving monthly benefits at 65. According to Social Security’s life expectancy calculator a 60-year-old man can expect to live 23 more years until age 83, while the life expectancy of a 60-year-old woman is slightly higher – 86.
If you’re a man who opts for the monthly payments at 65, that means you could expect to live another 18 years and collect a total of 216 monthly pension payments. In this case, the sum of the monthly payments is $432,000 (before income taxes).
If you’re a woman, you could expect to live another 21 years beyond age 65 and collect a total of 252 monthly payments. Those payments would add up to $504,000 (before taxes).
Next, you would want to do some rough math to determine how much the $400,000 lump sum would be worth if you rolled it over into a Roth IRA and took regular withdrawals from it. You would owe approximately $100,000 in taxes on the money up front, so let’s assume that you would have $300,000 leftover after taxes to invest.
Using a specialized savings distribution calculator, you could determine whether the lump sum option is preferable to the monthly payments. For this you would need the following:
Principal: $300,000
Time horizon: 23 or 26 years
Average annual return: 7%
Amount of regular withdrawals: $2,000 per month
If you start with $300,000 and earn a 7% average annual return over the next 23 years, while withdrawing $2,000 per month, you could have approximately $91,000 leftover at age 83. If you lived until age 86, you could still have around $32,000 leftover.
This analysis suggests that the lump sum option is more valuable than the monthly payment option if you lived until around 87. If you lived longer, the monthly payment option may support your needs more efficiently.
Then again, you don’t need to do all of this yourself. A financial advisor can help you make your decision after running calculations using a variety of assumptions and inputs.
A retiree smiles after finalizing his plan to take a lump sum from his pension plan.
This simplified example doesn’t include some other potentially important factors. They include:
Other income: Social Security, part-time work or other income may let you withdraw less from your investment portfolio, giving the lump sum option greater value.
Inflation: If inflation is high, the monthly payment option could lose significant purchasing power over time.
Self-discipline: If you aren’t sure you can resist the temptation to spend a large sum of money, the monthly payment option may be safer for you.
Comparing the relative value of a $400,000 lump sum to a monthly benefit of $2,000 calls for some calculations as well as some educated guesses. You’ll need to look at when you will receive the lump sum as well as when you can start collecting monthly benefits. Your current age and how long you expect to live are also important. Cost of living increases, any other sources of income and your own ability to effectively handle a big lump sum payout can also be significant factors.
Consider consulting with a financial advisor when you are making a significant decisions regarding your plan for retirement. 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.
As you approach retirement it’s important to assess the tax environment of the state in which you plan to retire. SmartAsset’s retirement tax friendliness tool can help you do that, providing you a look at the states most and least friendly to retirees.
Keep an emergency fund on hand in case you run into unexpected expenses, even in retirement. 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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