Retirement
The Pension Decision: Lump Sum vs. Lifetime Annuity – Which is Safer?
The Pension Decision: Lump Sum vs. Lifetime Annuity – Which is Safer?
CORE INSIGHTS
- Inflation is the Enemy: A fixed monthly pension (Annuity) loses ~50% of its purchasing power over 20 years at 3% inflation. A Lump Sum invested can hedge against this.
- Legacy Control: The Annuity typically dies with you. The Lump Sum becomes a tangible asset (IRA) that passes to heirs.
- The 6% Hurdle: Mathematically, if the annuity payout is less than 6% of the lump sum, taking the cash and investing it is often superior.
Retiring with a Pension is a luxury, but it comes with a high-stakes choice: Guaranteed Income or Lump Sum? The monthly check feels safe, but it carries hidden risks: Mortality Risk (dying early) and Inflation Risk (purchasing power erosion).
What-If Scenario: The Inflation Trap (20 Years)
| Timeframe | Monthly Check | Real Value (3% Inf) |
|---|---|---|
| Year 1 | $3,000 | $3,000 |
| Year 10 | $3,000 | $2,230 |
| Year 20 | $3,000 | $1,660 |
Visualizing Purchasing Power Erosion
*Figure 1: Real Value over 30 Years. The Annuity (Red) crashes; The Invested Lump Sum (Green) fights inflation.*
Strategic Action Steps
1
Run the IRR Calculation
Calculate the Internal Rate of Return. If the pension payout is >7% annually, it’s a good deal. If <5%, take the Lump Sum.
Calculate the Internal Rate of Return. If the pension payout is >7% annually, it’s a good deal. If <5%, take the Lump Sum.
2
Assess the “Spousal Gap”
If you take the Life Only pension, your spouse gets $0 when you die. To protect them, you must take a reduced “Joint & Survivor” payout. Compare this reduced amount to the Lump Sum.
If you take the Life Only pension, your spouse gets $0 when you die. To protect them, you must take a reduced “Joint & Survivor” payout. Compare this reduced amount to the Lump Sum.
3
Execute Direct Rollover
If choosing Lump Sum, do a Direct Rollover to an IRA. Never touch the check, or you trigger 20% withholding taxes.
If choosing Lump Sum, do a Direct Rollover to an IRA. Never touch the check, or you trigger 20% withholding taxes.
The Bottom Line: Who Should Choose What?
- Choose Annuity: “Spenders” who might run out of money if left to manage it, or super-healthy longevity optimizers.
- Choose Lump Sum: Investors who want to leave an inheritance or fear inflation.
Frequently Asked Questions
What is the biggest risk of a Monthly Annuity?
Inflation. Most private pensions do not offer COLA. A fixed check loses real value every year.
Why choose the Lump Sum?
Control. You can invest to beat inflation, access cash for emergencies, and pass the balance to heirs.
When does the Annuity win?
If you live significantly longer than average or if the payout rate is exceptionally high (>7%). It is longevity insurance.
Disclaimer: This content is for informational purposes only. Pension decisions are irrevocable. Consult a professional.