3 Steps to Help Evaluate Your Pension: Lump Sum or Regular Payments

By Matt Kasper

August 16, 2021

3 Steps to Help Evaluate Your Pension: Lump Sum or Regular Payments

Key Points – 3 Steps to Help Evaluate Your Pension: Lump Sum or Regular Payments

  • Understanding Your Pension
  • Preparing for the Race
  • Understanding the Reality of Investing
  • Questions About Pensions
  • 7 minute read

3 Steps to Help Evaluate Your Pension: Lump Sum or Regular Payments

The Rare Feat of Retiring with a Pension

I want to congratulate all those fortunate enough to have a pension option. Pensions as an employee benefit are on the decline, but for some, pension benefits will contribute to a meaningful and lasting retirement, and you need to make sure you are prepared to make the right decision.

The Even Rarer Feat of Winning an Olympic Medal

Additionally, I would like to congratulate all the Olympic athletes and our US Olympic family, which ended with an outstanding 113 medals. Double digits over the nearest competition. 

In the spirit of the Olympics, I will discuss a track & field event to help illustrate how you need to evaluate the tradeoffs of your pension versus a lump sum option.

Hurdling Over the Competition

Sydney McLaughlin set another world record in the women’s 400-meter hurdles. She finished with a time of 51.46 seconds, shaving 0.44 seconds off her previous world record. 

If Sydney were competing in the 100-meter hurdle, she would have to overcome hurdles standing 33 inches tall. However, fortunately, the 400-meter hurdle stands at 30 inches tall, allowing the sprinter some relief in height while going four times the distance. 

While three inches may not seem to be a big difference, this is a 10% percent increase in height, and for every ten hurdles, this would add 30 inches or, in this case, one extra hurdle! 

Understanding Your Pension to Run the Race of Retirement

When we think about your pension, clearly the height of the hurdle, your pension payment, and the longer the distance, your longevity, are key to understanding the pain and pressure a lump sum decision would have to last to overcome the certainty of your pension. 

Step One: Get Ready! 

Preparing for the Race

Hurdle Rate = Value of the Pension Payment x 12 ÷ Value of the Lump Sum

For example, if you have a $500,000 lump sum payment versus a $2,500/month or $30,000/year pension, your hurdle rate would be 6%. 

The internal rate of return you would need to generate to reproduce the same pension payments over your lifetime. Let’s define multiple hurdle rates for the same $500,000 lump sum and later identify the tradeoffs between the rates in Table 1 below:

Pension - Table 1


The next step is to determine how much time it would take for the pension payments to breakeven with the lump sum and assume no return in the stock market but secured in a cash position. Unfortunately, life span is not in our control, and you are right to have reservations on life expectancy and missed opportunities by starting a pension payment. 

Identifying if one lives 5, 10, 15, 20, 25, or 30 years in retirement will help you understand what we gain or lose depending on our pension election. Based on someone with a pension payment option of $20,000 (our lowest hurdle rate of 4%) versus a lump sum payment of $500,000 would have to live 25 years just to breakeven, yikes! 

If your retirement only lasted five years, you risk losing 80%, that’s $400,000 of what you would have as a legacy from the lump sum. Twenty years into retirement, you would have missed out on 20% of the value of the lump sum ($100,000). 


Now let’s shift gears. What if your pension payment has a 7% Hurdle Rate at $35,000/year? You now meet the breakeven in 14.3 years, and in 30 years, you would have received $1,050,000. All without the risk of the stock market and over double the lump sum amount. 

Below you will find a table looking at our four hurdle rates and the pension payment deficit or surplus versus the lump sum over multiple time horizons in Table 2 below:

Pension - Table 2


Step Two: Get Set!

Understanding the Reality of Investing

Our next step is understanding the “reality of investing” the lump sum versus the pension. This analysis will take the same four hurdle rates and only use historical returns that have taken place, no hypothetical numbers. Let me quickly explain the facts for this analysis.

  • Time Horizon: 30 Years
  • Number of Rolling Periods: 66
    • A rolling period is identifying how many 30-year sequences of history can we calculate: For Example, a rolling period is 1991 – 2021, then 1990 – 2020, and we go all the way back to 1926-1956.
  • Three Investment Risk Levels: Low Risk 30% /70%; Moderate Risk 60%/40%; High Risk 80%/20% (Stocks/Bonds)
  • Fee: 1% (Fees will vary by investment election and guidance provided)
  • Effective Tax Rate: 20% (Taxes will vary by individual or family)

NOTE: I did not include inflation to keep this analysis apples to apples of a fixed pension payment versus a lump sum. One fact to understand this analysis does identify the pressure of your RMD “Required Minimum Distribution” an unfortunate truth for a lump sum

What are the Results?

Pension - Table 3


Now to the results. The probability of success of the lump sum covering the hurdle of pension payments over 30 years is calculated in Table 3 above. 

The 4% and 5% hurdle results are all satisfactory, but surprisingly the low-risk and moderate risk had 100% success, and at 5%, high risk experienced 98% success, meaning only 1 of the 66 rolling periods failed. 

The one rolling period that failed was 1929 – 1959. Starting your Lump Sum and going into the Great Depression was the only sequence of time to fall short of meeting the guarantee of the pension payment. 

Raising the Bar

Moving on to a taller hurdle, low-risk moves to caution at 6% and into a Hazard at 7%. Hazard meaning very low confidence. 

Moderate risk and high risk remain satisfactory through 6% and move to caution at 7%. Concluding once our hurdle rate crosses 6%, you need to know confidence begins to drop, and your tolerance of investment risk is a major factor. 

Risk-averse investors need to be aware that the taller the hurdle, the more risk you may need. That is what we define as risk capacity, not risk tolerance.

The Fear of Running Out of Money


Let’s dig in. Once again, in Table 3, the results and success may appear to be favoring the Lump Sum and even taking on more risk, but let’s not lose sight of the earliest depletion years. The 7% hurdle rate with a high-risk portfolio has the caution flag for a reason. 

While high risk outperformed the pension payments 89% of the time, high risk also experienced a rolling period with the earliest depletion year of 13 years. Meaning you ran out of money in year 13, leaving nothing for the remaining 17 years of your 30-year retirement. 

That’s the fear you face when the lump sum is up against a high hurdle rate and taking on a high level of investment risk combined with market uncertainty. 


Now let’s review the 4% hurdle in Table 4, all risk levels are satisfactory with a 100% success, and now we want you to be aware of your potential loss of legacy going forward with pension payments. 

The historical low is the worst 30-year rolling period experienced at each risk level. Out of the 66 rolling periods, the number one losing period that experienced the worst 30-year sequence of return still had $387,118 left at the low-risk investor; moderate had $516,060; high had $392,582.

The historical median, the average rolling period, for the low-risk investor ended with $1,616,849; moderate with $2,676,838; and high with an incredible $3,633,108.

Not only did you cover the pension, you also left a strong legacy. The fields are left blank in Table 4 identifies their historical low. That means you ran out of money in those worse case sequences.

Step Three: Go! 

It’s Implementation Time

Time to implement, unfortunately, that’s a hard Forrest Gump style stop. Determining the best pension option goes well beyond identifying a hurdle rate and understanding historical probabilities. 

Ben Franklin said “In this world nothing is certain but death and taxes” a close third for your retirement plan is Inflation. What happens to your historical probability of success when you include a 3% inflation factor? Let’s take a look below at Table 5.


Confidence goes out the door now starting at 5% for low-risk investors and concern across all risk levels at 6%.

Questions About Pensions

Step three covers questions such as: 

  • Is my pension solvent? 
  • What are my survivorship options or term options? 
  • Do I have a cost-of-living adjustment, better known as COLA, to keep up with the inflation?

Now planning questions such as:

  • How does inflation impact my decision? 
  • How should I build this income into my tax strategy? 
  • Does this impact my Social Security timing decision? 
    • Assuming your pension doesn’t reduce or remove your Social Security options, could the lump sum make my Medicare more expensive.
  • How does this impact the future of my RMDs? 
  • Will my taxes go up because of it?
  • And on, and on

Living Your One Best Financial Life

I also want to break this down to how you live your best financial life as well: 

  • For all you spenders, taking that lump sum may stand out as a green light. Keep in mind the high probabilities are based on a disciplined withdrawal strategy. You would have to avoid big purchases and buyer’s remorse. Remember, a spending discipline is naturally built into your pension. You can spend every cent of your pension, without concern, this may help you.
  • This also holds true for those that tend to protect their assets. Statistically, you are not spending your assets or creating the memories you worked so hard for to get to retirement. Pension payments coming in every month allows you to spend this income freely, knowing you will not outlive your pension or worry about the success or failure of the stock market.
  • Individuals committed to family legacy need to understand the potential loss of legacy if pension payments are selected.

Do the Analysis

The Hurdle Rate analysis is critical to gaining clarity on the value of your pension versus the lump sum option. Unfortunately, there is not a universal truth. Whether you live 10 or 30 years in retirement, pension payments can eliminate the worry of running out of money. 

Of course, if you take the lump sum, you have the potential for growth, enhanced cash flows, and the likelihood of leaving a legacy. Hurdle rates also help with Annuity options and even rental income vs. selling a home or property (we need a few more facts for the calculation but the same concept). 

The way you build confidence in this decision is by designing a complete financial plan around your priorities. With proper guidance from experts, you can gain control over these difficult financial decisions.

Matt Kasper, CFP®, AIF®
Financial Advisor

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.