Types of Pension Payouts: Lump Sum vs. Monthly

A lump sum pension payout allows retirees to receive the present value of their pension benefits upfront rather than in ongoing monthly payments. This option provides flexibility, enabling individuals to invest, spend or manage their funds as they see fit. However, taking a lump sum means assuming responsibility for financial planning, tax implications and potential market risks. In contrast, a monthly pension payout offers a steady stream of income, which can provide long-term stability.

A financial advisor can build a roadmap for your long-term goals, including retirement.

Pros and Cons of Monthly Pension Payouts

Monthly payouts are a great option for retirees for a few reasons. First, receiving a regular payout each month helps you stick to your budget in retirement. This is because they work similarly to traditional checks that you earn from a job. As a result, it should be easier to keep your retirement spending under control, helping you meet your financial obligations each month.

Some pension plans will adjust their monthly payouts for inflation. This obviously isn’t a benefit that single lump sum payouts can match.

Monthly pension payouts provide financial security in retirement, as they typically continue until death. In some cases, they are even transferable to a spouse. Because of this, there’s little risk of running out of money in retirement as long as the plan can meet its obligations.

One major drawback of this payout option is that when you die, your monthly pension payments may stop. That means you could wind up leaving a lot less cash to your children, grandchildren and other beneficiaries. Some plans allow transfer to a spouse, but other plans may not. Be sure to check with your plan administrator to see if benefits continue after death so you and your family can plan your estate accordingly.

While it’s unlikely, you could lose some of your pension benefits if your former company goes bankrupt and you elect monthly payouts. However, the Pension Benefit Guaranty Corporation (PBGC) insures most private-sector defined benefit pensions, which pays covered benefits up to legal limits if an insured plan fails. PBGC insurance typically does not cover government pensions, along with a few others.

Pros and Cons of Lump Sum Pension Payouts

A lump sum payout is exciting, but keep in mind that a lump sum pension payout also makes it easier to overspend in retirement. That new car or luxurious vacation may not seem like such a splurge when you’re looking at a six- or seven-figure savings account.

A lump sum payout allows flexibility in retirement spending, both for expected and unexpected costs. This includes both expected and unexpected costs, like housing and healthcare. For example, if you have a serious health condition and need around-the-clock care, your lump sum would come in handy.

Another positive of a lump sum payout is you’ll be able to invest your money exactly how you want. On the other hand, monthly payments might hamstring your investment capabilities. Consider consulting a financial advisor to help invest the money and structure withdrawals.

If you plan your investments and withdrawals right, you’ll also be able to leave the rest of your lump sum to your children, grandchildren, relatives and other beneficiaries. This can help set your mind at ease throughout retirement, knowing that your family has support after you pass away.

However, there are a few drawbacks of the lump sum payout option. A lump sum is finite, while monthly pension payments continue at least until your death. This means that you’ll have to be significantly more diligent about how you manage your lump sum payment. Plus, with life expectancies on the rise, who’s to say that a lump sum will actually last you through retirement or beyond?

Regardless of your retirement savings, maintaining a structured monthly budget is beneficial. Living frugally in retirement could entail any of the following:

• Planning for healthcare costs
• Moving to an area with a lower cost of living
• Reducing discretionary expenses, such as dining out or cable subscriptions
• Rethinking a life insurance policy

Calculating a Monthly Pension

Understanding pension payout calculations can help your financial planning.

Let’s say you’re opting for monthly pension payments. Every pension plan has different terms. However, many traditional pension plans use an average of your highest-paid years as a starting point for calculating benefits. The number of years included varies by plan.

Once this number is clear, it’s multiplied by the percentage factor for your plan. You then multiply the subsequent number by the amount of years you were employed at the company. The product of that calculation equals your annual pension payout. To see how that’s split up over each month, divide your annual pension payout by 12.

The table below illustrates how you can figure out what your pension plan will pay you on a monthly basis. For reference, this example assumes that you worked for your employer for 30 years, that your plan uses your three highest years of compensation for calculations and that your plan’s percentage factor is 1.50%.

Determining the size of your potential lump sum pension payment is a much more personal process. For the most part, these payments come from what you would receive as a monthly benefit and current interest rates.

More specifically, a lump sum generally reflects the present value of expected future pension payments, rather than the simple total of those payments. The calculation depends on factors such as interest rates, mortality assumptions, your age and the plan’s terms. Lower interest rates generally produce larger lump sum values, while higher rates generally produce smaller ones. Speak to your employer for more information about what you could be in line to receive.

Lump Sum vs. Monthly Payouts: Which Is Best for You?

The answer to this conundrum isn’t black and white. The choice between lump sum and monthly pension payouts depends on many factors. Principal among these include your spending style, whether you have a spouse or other dependents, whether you have a health condition that may limit your life expectancy and the financial health of your former employer.

If you think you have a long life ahead of you or if you’re most comfortable budgeting a regular income, lifetime monthly payments may be a better fit. If you prefer control over withdrawals and investments, a lump sum may be more appealing, provided you’re comfortable managing the risk of running out of money. The value of each option also depends on the amount offered, inflation protection and any survivor benefits.

Planning for retirement involves multiple financial considerations, so take your time evaluating options. Involve your family in discussions regarding your pension payout decision. Consider your ultimate financial goals for retirement, the current status of your health and any long-term conditions that may affect your life expectancy.

How Taxes Affect Lump Sum and Monthly Pension Payments

Taxes can make a meaningful difference when comparing pension payout options. Monthly payments from a traditional pension are generally subject to federal income tax as you receive them, although part of each payment may be tax-free if you made after-tax contributions to the plan.

Taking a lump sum directly can create a much larger tax bill in the year of distribution. If the payment is entirely taxable, the full amount generally counts toward your ordinary income, potentially pushing some of it into higher federal income tax brackets. Depending on your age and circumstances, an additional tax on early distributions may also apply.

An eligible lump sum can generally be transferred directly into a traditional IRA without triggering immediate federal income tax. The money remains tax-deferred until you take taxable distributions from the IRA. If you instead receive an eligible rollover distribution directly, the plan generally must withhold 20% of its taxable amount for federal income taxes, even if you intend to roll it over within 60 days. ¹

For a $300,000 fully taxable lump sum, that withholding would be $60,000, leaving you with $240,000. To complete a full indirect rollover, you would need to deposit the entire $300,000 into an eligible retirement account within the applicable deadline, replacing the withheld $60,000 from other funds. A direct rollover avoids this withholding requirement.

The choice also affects when taxes are paid. A rollover allows you to spread taxable withdrawals over future years, while monthly pension payments generally create taxable income as they’re received. State income taxes and the tax treatment of survivor benefits can further affect the comparison.

Bottom Line

As with any financial decision, your choice should be based on your personal circumstances. For many people, the decision to take a lump sum or monthly payments depends on how much they have saved for retirement in other places. If you have significant savings in an IRA or Roth IRA, structured monthly payments may be preferable. But if your pension account is the main contributor to your retirement income, then a lump sum could be preferable.

Tips to Help You Plan for Retirement

• Consider working with a financial advisor to help with retirement planning. An advisor can help you decide between a monthly payment and the lump sum, as well as how to invest your assets. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with 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.
• Although it would be difficult to live off of Social Security alone, these extra payments can really help. To figure out about how much you could receive from the federal government, stop by SmartAsset’s Social Security calculator. If you have a government pension coming your way, it’s possible your Social Security benefit will shrink.

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