Deciding whether to take a lump sum of $400,000 or a monthly pension benefit of $2,000 requires calculating the relative value of each option. Generally speaking, the sooner you receive a lump sum, the more valuable it is because you can invest over a longer period of time. If you expect to live a long time after you start receiving benefits, the monthly payment option may be more valuable. Other factors include inflation, your additional sources of income, and how carefully you manage large sums of money. Big financial decisions, such as choosing between a lump sum or monthly payments, can benefit from the help of a financial advisor.
Sometimes companies with pension plans offer current and future retirees the option of receiving a large one-time payment, rather than a series of smaller payments that are typically administered on a monthly basis. These acquisitions represent one way for companies to manage risk while also providing some potential advantages to retirees.
Deciding whether to accept a one-time offer requires evaluating many factors. Some of them—such as the size of a lump sum or monthly benefits—are clearly specified in advance. As with other key variables, such as expected investment returns or future inflation, assessments must rely on educated guesses about future developments.
The two most critical variables are the timing of the lump sum and the employee’s life expectancy. Generally speaking, the earlier you pay the one-time fee, the higher the value of the option. Likewise, the longer the beneficiary’s life expectancy, the higher the value of the payment stream.
Some factors to evaluate include the beneficiary’s current health, the age at which a parent died, and the typical life expectancy for someone of his or her age and gender.
Other personal circumstances may also tip the scales. For example, someone with a lot of high-interest debt may be better off getting a lump sum payment that allows them to pay off the loan. On the other hand, people who are not confident in their ability to handle large sums of money discreetly may find monthly payments to be a safer option.
If you’re faced with the choice between taking a lump sum or annuity or monthly payments, a financial adviser can help you weigh your options.
An old man calculated how much income a pension would bring him.
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What would you do if you were faced with a choice between a lump sum of $400,000 or $2,000 a month for the rest of your life?
Assuming you are currently 60 years old, you can receive a lump sum payment immediately. Alternatively, you can start receiving monthly benefits at age 65. According to Social Security’s life expectancy calculator, a 60-year-old man can expect to live another 23 years, until age 83, while a 60-year-old woman has a slightly higher life expectancy of 86 years.
If you are a man and choose to receive a monthly pension at age 65, this means you can expect to live another 18 years and receive a total of 216 monthly pension payments. In this case, the total monthly payments would be $432,000 (before income taxes).
If you are a woman, you can expect to live another 21 years after age 65, receiving a total of 252 monthly payments. These payments totaled $504,000 (before taxes).
Next, you’ll want to do some back-of-the-envelope calculations to determine how much the total $400,000 would be worth if you contributed $400,000 to a Roth IRA and made regular withdrawals from it. You’ll owe about $100,000 in prepayment taxes, so let’s assume you have $300,000 left over after taxes to invest.
Using a dedicated savings allocation calculator, you can determine whether a lump sum option is better than monthly payments. To do this you need the following:
main:300,000 USD
time range: 23 or 26 years old
average annual return: 7%
Regular withdrawal amount: USD 2,000 per month
If you started with $300,000 and earned an average annual return of 7% over the next 23 years while withdrawing $2,000 each month, you might have about $91,000 left at age 83. If you live to age 86, you may still have about $32,000 left.
This analysis shows that if you live to be around age 87, the lump sum option is more valuable than the monthly payment option. If you live longer, a monthly payment option may work better for your needs.
Then again, you don’t need to do all this work yourself. A financial advisor can help you make a decision after making calculations using various assumptions and inputs.
A retiree smiles after finalizing a lump sum payment from his pension scheme.
This simplified example does not include some other potentially important factors. They include:
other income: Social Security, a part-time job, or other income may allow you to withdraw less money from your portfolio, making the lump sum option a greater value.
inflation: If inflation is high, monthly payment options may lose a lot of purchasing power over time.
self-discipline: If you’re not sure you can resist the temptation to spend a large sum of money, a monthly payment option may be safer for you.
Comparing the relative value of a one-time benefit of $400,000 versus a monthly benefit of $2,000 requires some calculations and some educated guesswork. You need to consider when you will receive your lump sum payment and when you can start receiving your monthly benefits. Your current age and life expectancy are also important. The increased cost of living, any other sources of income, and your own ability to effectively handle a large lump sum payment may also be important factors.
When you are making important decisions about retirement planning, consider consulting with a financial advisor. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory call with your advisor to decide which one you think is the best fit for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started today.
As you approach retirement, it’s important to evaluate the tax environment in the state where you plan to retire. SmartAsset’s Retirement Tax Friendliness Tool can help you do just that, letting you know the most and least retiree-friendly states.
Keep an emergency fund on hand in case you encounter unexpected expenses, even in retirement. An emergency fund should be liquid—held in an account that is not at risk of large swings like the stock market. The trade-off is that the value of liquid cash may be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts at these banks.
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