Lump-Sum vs. Pension Payments: What’s the Difference?

Lump-Sum vs. Pension Payments: An Overview

Those approaching retirement and eligible for a pension often weigh accepting the traditional, lifetime monthly payments or taking a lump-sum distribution.

Monthly pension payments are a fixed dollar amount, begin at retirement, and last until a retiree’s death. Some plans offer a survivor’s benefit for a living spouse. A lump sum distribution is a one-time cash disbursement at retirement. The retiree is solely responsible for managing the funds throughout retirement.

Key Takeaways

• Pension payments are made for the rest of a retiree’s life.
• Lump-sum distributions allow individuals to spend or invest the money.
• People who take a lump sum may outlive their money, while traditional pension payments continue until death.

Lump-Sum Distribution

A lump-sum distribution is a one-time payment from a pension administrator. Individuals have access to a large sum of money they can spend or invest.A pension payment annuity is commonly a fixed payment, but a lump sum offers flexibility and, if invested properly, may also provide regular income. Those who take a lump-sum distribution can name a beneficiary to receive any money left after death.

Income from pensions is taxable. However, individuals can roll over a lump sum into an IRA and control when to withdraw the funds and pay income tax. Retirees will eventually have to take required minimum distributions (RMDs) from their IRA, but that won’t happen until age 72 or 73.

Rolling a lump sum pension payment into an IRA lets individuals plan when they take their distributions—and when they’ll pay the associated taxes.

Pension Payments

A 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 are indexed to inflation.A regular pension check can help retirees budget and control overspending. Retirees with company health insurance may need to opt for pension payments because coverage may stop if an employee takes a lump sum.

According to research from the Consumer Financial Protection Bureau, retirees in 2020 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 level after five years, compared to only 56% of those who had chosen the lump sum.

One threat to pensions is that an employer fails to pay long-term. However, pension benefits are safeguarded by the Pension Benefit Guaranty Corporation (PBGC), a government entity that collects insurance premiums from employers sponsoring insured pension plans. The PBGC only covers defined-benefit plans, not defined-contribution plans like 401(k)s.In 2024, the maximum annual benefit is $85,295.40 for a straight-life annuity for a 65-year-old retiree.

Important

If a pension administrator goes bankrupt, pension payments could stop, though Pension Benefit Guaranty Corporation (PBGC), a federal agency, insurance covers most people.

Key Differences

Lump Sum

• All pension money is distributed at once at retirement

• The retiree must manage the funds throughout retirement

• Lump sum money can be rolled over into an IRA

• Retirees can designate beneficiaries of the funds

Pension Payments

• Payments are made monthly to the retiree until death

• The PBGC provides insurance in case the pension administrator is unable to pay

• Monthly payments may cease once the retiree dies unless there are survivor’s benefits

• Companies may require retirees to take monthly payments to keep health insurance benefits

How Do Companies Calculate Pension Payments and Lump Sum Distributions?

From an actuarial standpoint, the typical recipient receives 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. Retirees with a longer-than-average lifespan will probably receive more money taking lifetime payments.

What Are the Disadvantages of Taking a Lump Sum?

Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. 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. Retirees who choose a lump sum could put part of a lump sum into a fixed annuity with the help of a financial advisor.

Is a Pension Plan the Same as a Defined Benefit Plan?

Yes, a private pension plan is a defined benefit plan where the employer makes most contributions on behalf of the employee for their retirement.

The Bottom Line

For some, a lump-sum pension payment makes sense. For others, having less upfront capital is better. In either case, pension payments should align with a retiree’s personal goals. A financial advisor can guide those considering whether to choose a monthly payment or invest a lump sum for the long term.

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