Pension buyout: take the lump sum or keep the checks?

The buyout offer

You work somewhere for 25 years, the pension vests, and at retirement you're handed a decision: take the monthly $2,500 for life, or take a one-time check of $400,000 and manage it yourself.

Financial advisors get paid real money to model this. The underlying math fits on a cocktail napkin.

Present value with a napkin

A dollar today is worth more than a dollar in 20 years, because it can grow in the meantime. Discounting the pension's future payments back to today at a reasonable rate gives its present value.

At a 5% discount rate, $2,500 a month for 25 years is worth about $427,000. The $400,000 lump sum is cheaper than that, which means, all else equal, the pension's a better deal at a 5% view of the world.

At a 6% or 7% rate, the math flips, and the lump sum wins.

The Pension vs Lump Sum calculator does this exact present value calculation and, more usefully, solves for your break-even rate: the return your lump sum needs to beat the pension's guaranteed checks.

What that break-even rate really means

If the break-even is 5.2%, then you need to believe the lump sum can beat 5.2% invested before taking it makes sense. Historically the stock market does beat that, but not smoothly, and not guaranteed.

What none of the advisors say loudly enough: the pension is a guaranteed income stream that outlives your planning horizon if you live long. The lump sum is only as good as your discipline and your luck.

The life expectancy elephant

Every lump sum pitch assumes you die at the actuarial average. Someone in my family retired at 62 and collected the pension until 91. At that horizon the lump sum would have needed to earn far more than 5% to match, and it didn't.

Healthy people who plan to live long should lean pension. People with shorter life expectancies, or a genuine edge in managing money, can make the lump sum work. The math doesn't care about your feelings, but it does care about your health history. Run both sides, check your break-even rate, and sleep on it.