Personal Finance

My state pension will pay me $2.6 million over the next 20 years - should I trade it in for a lump sum of $418k today?

John Seetoo

Published: February 26, 2025 8:42 am

Retiring early, years before the average age of 65, has often been considered something for Millennials working in high-tech industries or other fast-growth, high-compensation occupations. However, a F.I.R.E. (Financial Independence Retire Early) strategy can benefit anyone willing to aggressively scrimp, save, and invest – even for those working in civil service. 

Savings and additional work that can qualify for social security payments can augment a state government pension. Depending on individual tax liabilities and other holdings, the combination can make for an early comfortable retirement nest egg.

The Lottery Scenario

A 54-year old Reddit poster seeking advice was able to take retirement from his job working for the state of Illinois over a 30-year stint. He was given the following option regarding estimated cost of living adjustments for the next 13 years.

Option 1: Receive an automatically compounded 3% annual COLA increase that will continue to pay the poster’s wife until her death, should she survive him. 

Option 2: Take a lump sum of $418,000 to be deposited into his IRA account, and receive no increase until the poster reaches age 67, at which point he would receive a non-compounded 1.5% annual increase. 

The poster’s current pension of $8,430 base amount per month (federal tax only; exempt from state tax) remains the same in either scenario, as does his healthcare. He had worked over the minimum number of weeks in the private sector prior to and at side jobs in order to qualify for a reduced Social Security benefit. 

The poster intends to work full time elsewhere for a few more years, and then part time afterwards.  His wife already works part-time and intends to do so until she decides otherwise. The poster and his wife have one daughter who is entering college on a full-boat scholarship for her first two years, but will require tuition funds from her parents for the last two years. The other children are all grown and on their own.

Similar to the option posed to Lottery winners, the poster is unsure whether to take the annual compounded payout or the lump sum.

Studying the Broader Picture

The options posed to the poster contain a number of other considerations that are considerably subjective, and possibly unique to the poster’s situation.  As such, the following questions arise:

• In the Option 2 scenario, the lump sum goes into the poster’s IRA. As pre-tax funds, they will be subject to federal income tax, and an elevated RMD, in the event he were to choose that route.
• As the poster is only 54, any early IRA withdrawal before age 59 ½ would be subject to a 10% penalty.
• Having the flexibility to invest IRA funds independent of any mandated state ERISA limitations could ostensibly grow the funds significantly, provided the stock market’s double digit bull rally growth continues. 
• Managing the portfolio on his own would depend on the poster’s personal fund management prowess, otherwise, additional management fees will eat into any potential gains.
• The next 13 years of option 2 would only see the $8,430 monthly base amount with no COLA and a non-compounded 1.5% annual increase after the poster reaches age 67.
• As the 3% annual COLA increase is compounded, the actual amount can be quite substantial over time. 
• In the event inflation once again rears its head to Biden Administration levels, option 2 can leave a nest egg fund devastated, whereas option 1 affords one more of a protective cushion.

Crunching Numbers

In a direct math calculation comparison, option 1 realizes the strength behind 3% annual COLA with compound interest, making the pension worth roughly $7.78 million over the next 40 years. Conversely, option 2 will be worth around $7.03 million over the same period, provided that the $418,000 can generate at least 5% gain annually. 

Clearly, there is a stronger reliability factor and subsequently lower risk to option 1, in addition to being around 10% more valuable over the long haul. Depending on the health quality of the poster’s wife, it can be worth an even greater amount, depending on how many years she outlives the poster as the 3% compounding continues until her own demise. 

As the poster and his wife both plan to continue working, even part-time, for at least the next 7 to 10 years, the additional income derived from this work will also add to the overall nest egg fund, even accounting for college tuition and any emergency needs of their daughter.

This article is written purely from an informational perspective. Anyone seeking more comprehensive advice should speak to a retirement finance professional.