● Money & small business
Pension lump sum or monthly payments? Break-even age and the return a pension pays
When an employer offers a lump sum instead of a monthly pension, the choice comes down to two numbers: the return you could earn on the lump sum, and how long you live. Every figure below comes from our pension lump sum calculator, which was checked against its spreadsheet and an independent calculation. The example: you're 62 and can take $2,000 a month for life from age 65, with no cost-of-living raise, or $300,000 now.
What the pension is worth today
A pension's value today is what you'd need to invest now to pay yourself the same income. It depends on the return you could earn: the higher the return, the less you'd need. Up to age 90:
| Return you could earn | Pension's value today | Pension − lump sum | Break-even age |
|---|---|---|---|
| 3% | $387,683 | +$87,683 | 82 years 7 months |
| 4% | $339,379 | +$39,379 | 85 years 6 months |
| 5% | $298,834 | −$1,166 | 90 years 3 months |
| 6% | $264,605 | −$35,395 | 100 |
| 7% | $235,542 | −$64,458 | not before 122 |
The break-even age is when the pension payments you've received, valued at today's dollars at that return, first add up to the lump sum. It's also the age at which the lump sum would run out if you invested it at that return and paid yourself $2,000 a month from 65. Live past it and the pension was the better deal.
The return the pension pays you
Turn the question around: if you give up $300,000 today, what yearly return do the pension payments give you? That depends only on how long you live:
| If you live to | Pension paid in total | Value today at 5% | Return the pension pays |
|---|---|---|---|
| 75 | $240,000 | $163,724 | −2.70% |
| 80 | $360,000 | $220,080 | 1.77% |
| 85 | $480,000 | $264,237 | 3.86% |
| 90 | $600,000 | $298,834 | 4.97% |
| 95 | $720,000 | $325,943 | 5.61% |
| 100 | $840,000 | $347,183 | 6.00% |
If you expect to live to 90 and could earn more than 4.97% a year on the lump sum after fees, the lump sum comes out ahead; if not, the pension does. Living to 100 makes the pension worth a 6.00% return with no investment risk.
A cost-of-living raise changes a lot
Some pensions, mostly public ones, rise each year. The same offer with a yearly raise, at a 5% return and to age 90:
| Raise a year | Pension's value today | Pension − lump sum | Break-even age | Return to 90 | Return to 80 |
|---|---|---|---|---|---|
| 0% | $298,834 | −$1,166 | 90 years 3 months | 4.97% | 1.77% |
| 1% | $329,333 | +$29,333 | 86 years 6 months | 5.73% | 2.44% |
| 2% | $364,356 | +$64,356 | 84 years 1 month | 6.50% | 3.10% |
| 3% | $404,661 | +$104,661 | 82 years 4 months | 7.27% | 3.77% |
Starting sooner
If the same $2,000 a month started right away at 65 against the same $300,000, the pension would be worth $345,938 today at 5% to age 90, $45,938 more than the lump sum, with a break-even age of 84 years 5 months: three years fewer of waiting makes a large difference.
What the numbers leave out
- How long you'll live is the biggest unknown. A pension is insurance against living a long time; a lump sum can run out, or be left to your heirs.
- Survivor options: a joint-and-survivor pension pays less per month but continues for your spouse.
- Taxes: both are usually taxed as income when you receive the money; a lump sum rolled over into an IRA isn't taxed until you withdraw it.
- Guarantees: private pensions in the US are insured by the Pension Benefit Guaranty Corporation up to a limit if the plan fails.
- Investment risk: a 5% average return isn't 5% every year, and a bad first few years hurt a lump sum you're drawing on.
Try your own offer in the pension lump sum calculator. For when to claim Social Security, see the Social Security claiming calculator.