A letter from a former employer can carry a big number. Take your pension as one lump sum, it says, instead of a monthly check for life. It can be tempting to say yes right away.
The number alone doesn’t tell you whether it is a good trade. Here is what to look at before you choose.
What You Are Really Choosing Between
A pension annuity pays you a set amount every month for the rest of your life. A lump sum pays you once, and then the money is yours to manage.
Each path has a clear upside. The monthly check works like keeping part of your paycheck for life, and it can continue to a spouse. The lump sum can pay off large debts, and whatever you don’t spend can pass to your heirs.
Each has a clear risk, too. A monthly check gives you less flexibility. A lump sum can run short if you live a long time or the money is not managed well.
The offer can show up at different points in life. PBGC notes that an employer may ask you to choose when you change jobs, when you stop working, or even after monthly payments have started.
Questions to Ask Before You Sign
Your plan administrator can answer most of these. Ask for the answers in writing.
- Can I take part of my benefit as a lump sum and part as monthly income?
- How was this lump sum amount calculated?
- Would the lump sum change my retiree health coverage or any other benefit?
- What would my spouse receive under each option?
If you are married, your spouse likely has a say. Many pension plans must pay married participants a joint and survivor annuity unless both spouses agree in writing to another form. A lump sum counts as another form, and a notary or plan representative must witness the spouse’s consent.
For a closer look at how retirees weigh the two choices, read this article.
The Tax Side of a Lump Sum
How you take the money matters as much as whether you take it. If the plan pays a lump sum to you directly, it generally must withhold 20 percent for federal income tax. That happens even if you plan to roll it over later.
To roll over the full amount, you would have to replace that 20 percent from other savings within 60 days. A direct rollover to an IRA or another eligible plan avoids the issue. Any taxable amount you keep may also face a 10 percent additional tax if you are under 59 and a half, unless an exception applies.
The Federal Backstop for Monthly Income
Many private pensions come with a safety net. The Pension Benefit Guaranty Corporation, or PBGC, is a federal agency that insures private sector defined benefit pension plans. If PBGC takes over a plan, it typically pays monthly benefits for life, up to limits set by law.
PBGC only offers a lump sum when the benefit is small. For plans that end in 2024 or later, that means a value of $7,000 or less.
That backstop covers private sector plans, not state or local government pensions. Your plan also sends an annual funding notice that shows how well funded it is. Read it before you decide.
PBGC suggests weighing your health, your investing skills, your living costs, your other income, and your debts. PBGC’s guide to choosing an annuity or a lump sum walks through each one in plain terms.
A Simple Test
Before you decide, picture yourself at 85. Would you rather have a check that still arrives every month, or a balance you have managed for 20 years? Neither answer is wrong. It just needs to be your answer, not the default on the form.
If you lean toward the lump sum, make a plan for it before the check arrives. Know where it will go, how it will be invested, and how much you will draw each year.