Should I Take the Pension Lump Sum or Keep the Monthly Annuity?

How to read the break-even analysis

The IRR is the single most useful number in this analysis. It's the annual return rate built into your pension offer. If your plan is offering a $400,000 lump sum in exchange for a $2,500 monthly annuity with no COLA over 23 years, that annuity has an implied IRR of roughly 5.2%. That's what you'd need to earn each year, guaranteed, to replicate those payments from an invested lump sum.

Compare that IRR to what you realistically expect from investing. A diversified 60/40 portfolio has averaged 6-7% annually over most 20-year periods since 1980. An all-equity S&P 500 index fund has averaged around 10%, but with stretches like 2000-2010 returning nearly zero. If the annuity's IRR is 4.5% and you expect 7% from a balanced portfolio, the math favors the lump sum. If the IRR is 7.2% and your realistic return assumption is 6%, keep the annuity.

The break-even year is where cumulative annuity payments first fall behind the invested lump sum's portfolio value. Past that year, the lump sum holder has more total dollars. Before it, the annuity holder has received more. The longer you live past the break-even, the less relevant it becomes: the compounding portfolio keeps growing, while the no-COLA annuity stays flat in nominal terms.

What the math misses

The calculator solves a math problem, not a life problem. Four things that can override the numbers entirely.

Longevity risk. If you live to 94, an annuity paying for 32 years looks extraordinary in hindsight. A lump sum taken at 62 and invested aggressively can be drawn down to zero by a bad sequence of returns in the first five years of retirement, well before you hit 85. Annuities are, by definition, longevity insurance. That insurance has a cost. Whether it's worth that cost depends on your family history and your confidence about your own health trajectory.

Behavioral risk is real and underrated. Studies on retirement income depletion consistently find that retirees with lump sums spend down principal faster than they expect, particularly in the first decade of retirement before spending patterns stabilize. The annuity removes that temptation. Not for everyone, but for a significant percentage of people who would be better served by automatic income than by a large investable balance.

Survivor benefits complicate the lump sum math. If you elect a joint-and-survivor annuity that pays 50% to a spouse after your death, the monthly amount is lower than the single-life figure. The correct comparison is between the lump sum and the joint-survivor annuity, not the single-life annuity. Using the single-life number in the comparison while planning to protect a spouse means the annuity column is overstated.

Disability provisions sometimes attach to the annuity but never to a lump sum. If your pension plan has a disability retirement benefit that would increase your monthly payment if you become unable to work, and you take the lump sum instead, that protection disappears.

COLA changes everything

A no-COLA annuity is a shrinking asset in real terms. At 3% inflation, $2,500 per month today has the purchasing power of $1,860 per month in 10 years and $1,380 per month in 20 years. That's not a minor erosion. It's a 45% cut in real income over two decades.

A 3% COLA annuity is a fundamentally different product. The same $2,500 payment becomes $3,360 per month in 10 years and $4,516 per month in 20 years. The implied IRR of a 3% COLA annuity is typically 2-3 percentage points higher than the identical benefit with no COLA, because every future payment is larger. To beat a 3% COLA annuity with an invested lump sum, you'd likely need to consistently earn 8% or more, which requires meaningful equity exposure and the willingness to ride out drawdowns in your 70s and 80s.

Most private-sector pensions have no COLA. Federal pensions (FERS, CSRS, military) and many state teacher and public employee pensions have full or partial COLA provisions. Check your plan document carefully. The COLA field in this calculator has a larger impact on the result than almost any other input.

Tax comparison

The IRS treats both paths identically if you execute the rollover correctly. Here's how it works.

Direct rollover to a traditional IRA: the full lump sum transfers trustee-to-trustee with no tax due at the time of transfer. The money grows tax-deferred. You pay ordinary income tax on withdrawals, exactly as you would on monthly annuity payments. Required Minimum Distributions begin at age 73. The tax outcome is the same as the annuity path, just with more control over the timing of withdrawals.

Lump sum taken in cash: the plan withholds 20% automatically for federal taxes. The full amount is added to your income in that year, potentially pushing you into a higher bracket. If you're under 59.5, a 10% early withdrawal penalty applies on top. This is almost never the right path for a large sum. The only exception is if you need immediate cash and have exhausted other options.

One real tax difference: Roth conversion opportunity. A lump sum in an IRA can be strategically converted to a Roth over several years in low-income years, creating tax-free growth. Monthly annuity payments cannot be converted. If you expect income to be lower for several years after retirement before Social Security begins, a rollover creates Roth conversion windows that the annuity path forecloses.

Who should almost always take the lump sum

Poor health with a realistic life expectancy under 78. The math tilts heavily toward the lump sum when you're unlikely to collect long enough for the annuity to pay out more than the lump sum is worth. At 62 with a terminal diagnosis, an annuity that pays $2,500 per month for six years totals $180,000 against a $400,000 lump sum. There's no actuarial argument for keeping the annuity in that scenario.

No survivor needs, combined with investment discipline. If you're single, or your spouse has their own substantial retirement income, the survivor protection argument for the annuity weakens. Paired with a genuine ability to invest without panic-selling during drawdowns, the lump sum's compounding advantage is hard to beat over 25 years at market returns.

Plan sponsor in financial distress. If your employer is a struggling company, a frozen plan, or a plan that has transferred obligations to the PBGC, the lump sum removes credit risk. PBGC coverage is capped at roughly $80,000 per year for plans terminated in 2025. If your monthly benefit would exceed that cap, the PBGC guarantee is cold comfort. Taking the lump sum and rolling to an IRA eliminates that exposure entirely.

Who should almost always keep the annuity

Strong family longevity with no other guaranteed income. If your parents lived to their late 80s or 90s and your only other retirement income is Social Security, an annuity that pays regardless of market conditions for the next 30 years is genuine insurance. You can't outlive it. That certainty has real value beyond what an IRR comparison captures.

Joint survivor provision for a dependent spouse. If you have a spouse who earns significantly less, has health problems, or would struggle to manage a large investment portfolio alone, the survivor annuity provides automatic income continuation. A lump sum left to a surviving spouse becomes a portfolio management problem they may not be equipped to handle.

Government pension with full COLA. Federal retirees with FERS or CSRS benefits, military retirees, and many state employees receive COLAs that track CPI. Over 25 years of retirement, a CPI-adjusted annuity competes with virtually any equity return assumption after accounting for the risk premium. The annuity's implied IRR is high enough that you'd need very aggressive equity allocation to beat it, and very aggressive allocation creates sequence-of-returns risk precisely when you can't absorb it.