Take a Monthly Pension Over a Lump Sum, Says Wes Moss

A caller named Alex phoned into The Clark Howard Podcast recently for help with a decision most pension holders only get to make once. Should he take $411 per month for life, or accept a $58,000 lump sum?

Investment strategist Wes Moss ran the numbers on air and suggested the monthly check is the better choice. Using the 6% test, you annualize the pension income and divide by the lump sum. If the result clears 6%, the guaranteed monthly payment is usually the stronger choice. Below 6%, the lump sum starts to win, because a diversified portfolio can reasonably be expected to earn that rate over time.

“$411 times 12 is $4,932 a year,” Moss said before dividing that by the $58,000 lump sum option. “Oh, 8.5%. Wow. That’s pretty strong. It’s hard to guarantee yourself 8.5%.”

Consider the current rate environment. The 10-year Treasury is yielding about 4.3%. The Fed funds rate sits near 3.8%. To replicate Alex’s 8.5% guaranteed payout with risk-free instruments, you would need the 10-year Treasury to roughly double. A single premium immediate annuity funded with the $58,000 would almost certainly pay less than $411 per month for a buyer at typical retirement age, because insurers price in their own margins on top of Treasury yields.

If Alex takes the pension and lives 20 years, the stream pays out $98,640. To match that from the lump sum, the portfolio has to compound at 8.5% net of fees, taxes, and sequence-of-returns risk every year without fail.

Moss’s recommendation carries a condition. “As long as you do it with a ‘period certain,’ because the last thing you want to do is have a pension amount and something happens to you, you die in 5 years, then they get to keep all the money.” A period certain election guarantees the pension pays out for a minimum number of years (commonly 10, 15 or 20) regardless of whether the retiree is alive to collect. A joint and survivor election extends coverage to a spouse, typically at a reduced monthly amount.

“When you elect these pension amounts, make sure they have at least a minimum amount of years that they get paid out,” Moss said.” So that at least you get your money back and you can have a joint pension that also covers your spouse.”

Who Should Take the Lump Sum

Moss’s answer fits Alex. It does not fit everyone with a pension offer. The lump sum is the better choice in three specific profiles:

1. The 6% test fails. If the annualized pension divided by the lump sum comes in at 4% or 5%, a diversified portfolio can reasonably match or beat the payout while preserving principal for heirs.
2. The plan sponsor is financially shaky. Pensions from underfunded private plans carry default risk.
3. Serious health issues shorten the expected payout window. A period certain helps, but if life expectancy is measurably below average, the lump sum’s flexibility for heirs often wins.

Also consider that inflation complicates even a strong 6% test result. The $411 check will buy less in year 20 than it does today.

Run the 6% test on your own offer. Multiply the monthly payment by 12, divide by the lump sum, and compare the result to current Treasury and investment-grade bond yields. Request the plan’s period certain and joint-and-survivor options in writing and compare the reduced monthly amounts against the single-life figure. If the math clears 6% and the employer’s plan is well-funded, the guaranteed check is the stronger asset.

Alex’s 8.5% is the easy version of this decision. Most readers will face a closer call, and that is where running the test, rather than guessing, pays for itself.