Personal Finance

Millions of Baby Boomers Face This Pension Dilemma: Lump Sum vs. Monthly Payments - Which Is Best?

David Beren

Published: February 10, 2025 1:51 pm

One of the most significant decisions anyone with a pension can make is taking a lump sum (annuity) versus receiving monthly payments. At some point, you’ll have to make a decision, and this decision can greatly impact your standard of living and lifestyle while you are retired. 

This is especially true for baby boomers, millions of whom are likely in this scenario right now as they prepare to retire and need to make some lifestyle decisions. There are benefits to both sides, as investing a lump sum can help it grow while monthly payments provide a sense of long-term stability. 

Lump Sum Versus Annuity Payments

To help make this simple, you’ll want to remember that a lump-sum payment would be a one-time payment from a pension administrator. While any lump sum would likely be taxable, you could roll it directly into an IRA, withdraw funds, and pay income tax as you usually would with an IRA. 

Separately, pension monthly payments, or annuity payments, as they are sometimes called, are payable for life. In many cases, this would include money directed toward the life of any surviving spouse and adjusting for the cost of living. 

Going the annuity route could help control overspending as long as the pension payer remains solvent, which is where the indecision comes into play. Considering that a 2022 MetLife study found that 35% of those who took the lump sum payout spent all of the money within five years, you can compare this against 96% of respondents in the same survey who took the monthly payout as being happy with their decision. 

According to Brian Skrobonja, founder and President of Skrobonja Financial, the lump sum route is only best if you want complete control of your assets at once. On the other hand, he recommends an annuity payment as the best way to benefit from a pension plan in the shortest period. 

What Are The Tax Implications?

Among the most important considerations when choosing between lump sum and annuity payments is directly related to taxes. The most important thing to know is that if you choose the lump sum option, you’ll owe income tax on the entire amount unless it’s rolled over to an IRA or other qualified retirement plan. 

Assuming you don’t roll a lump sum into an IRA, there is a strong likelihood a pension lump payout would push you into a higher tax bracket. As an employer is required to hold 20% of the total amount back for taxes, there is also this consideration that you are immediately losing this amount. There is a much lower chance that annuity payments won’t push you into another tax bracket, which reduces overall tax implications. 

For example, if you receive a $500,000 lump sum payment from a pension, you’d likely be subject to a 35% tax bracket or even 37% depending on regular income. However, with an annuity payment of $3,000 a month or $36,000 a year, this likely wouldn’t impact overall tax bracket standing. 

Potential Investment Returns 

While the idea of tax implications favors taking annuity payments, the opposite might be true when considering potential investment returns. If you receive a lump sum payout, you can invest the entire amount into mutual funds, stocks, bonds, or any other retirement vehicle that could generate positive returns. 

While market volatility certainly plays a role, assuming the market continues to climb steadily, a financial advisor could create a portfolio that generates conservative returns within your risk tolerance level. 

However, if you want a more conservative approach to investing and don’t want to put all your eggs into one basket, the annuity approach better protects potential investments from market volatility. 

Risk Tolerance

When investing any pension earnings, the decision comes down to your comfort levels and risk tolerance. There is little debate that a lump sum assumes more risk. If you invest the money too aggressively, you might find that market volatility wipes out a lot of your earnings quickly. 

The same goes for being too conservative, as you might not see enough growth to be impactful. The decision might be easier if you have a high-risk tolerance and are already invested in the market. Of course, it’s easy to say. 

Those who choose the annuity payment might find more comfort knowing they have a steady income protected against market volatility. The better question might be how much your retirement income depends on market growth versus how much is guaranteed in pension payments or Social Security. If you are comfortable with the balance, go with the lump sum. If the answer is you are not comfortable with the balance, go with the annuity payment. 

Steady Income Needs

The most straightforward answer here for any retiree who prioritizes the need for reliable income to cover essential expenses like housing or healthcare may know that the annuity is right for them. Taking this one step further, a retiree relying solely on a pension plan and Social Security might rely on annuity payments to cover the cost of living. 

However, suppose you already have sufficient sources of income from an existing portfolio, an existing annuity, or Social Security. In that case, you might be okay with investing the lump sum for future use. Any lump sum investment could also generate enough returns that this money could be passed on to beneficiaries, including children or a living spouse. 

Inflation

One consideration is to verify with any pension plan whether the annuity payment carries a cost-of-living adjustment. If it doesn’t, there is a better-than-good chance it will lose buying power over time.

In this case, a lump sum payment might be the better option as you can invest it into something like a Treasury Inflation-Protected Security that will better keep up with rising costs. There would be market risks involved, so risk tolerance becomes a question, but this may be less of a concern than losing buying power over a couple of years. 

Life Expectancy

Life expectancy arguably gets the least attention of all the considerations worth exploring. If you or your spouse are healthy and believe you will live beyond the average life expectancy in the US of 77.43 years of age, the idea of monthly annuity payments might be more attractive. 

Alternatively, if you don’t expect to live much beyond the average life expectancy, the lump sum payment might help you get more out of the years you have left. Any remaining money from the lump sum would then be passed onto your heirs, creating generational wealth. Of course, you must also balance your spending so you don’t run out of money too fast. 

Hypothetical Scenario 

Let’s assume for a minute that your lump sum pension payment begins at 65 and is an estimated $250,000 paid as a single payment. This $250,000 now has to last you for an unknown period, with the hope that you will live well beyond the average life expectancy. 

Consider a lifetime annuity payment of $1,500 per month or $18,000 per year. If you live 14 more years and surpass the average life expectancy, your annuity payments will total $252,000, earning you more than the standalone lump sum. 

It’s easy to counter this argument by saying what about any money earned from investing the $250,000, but since investments are not guaranteed, the best way to make your decision is based on the numbers you know to be true. In this case, if you expect to live long, the annuity payment is the better choice.