Should You Take a Lump Sum Payout or a Pension?

What to do when unforeseen circumstances force you to make early decisions

Envelope filled with cash

Peter Dazeley / Getty Images

Many people spend years planning and working toward their retirement. They carefully craft their plan based on factors like the age at which they hope to retire, how much money they will need to save and live on. But what happens when you have a solid retirement plan in place and circumstances beyond your control push your retirement plan forward earlier than expected?

It's a fairly common scenario that everyone should be prepared to face. According to the Employee Benefit Research Institute, 46% of retirees enter retirement earlier than they planned, and only a quarter of them willingly chose to retire early. The main reason for taking an early retirement differs by race. While white retirees said they could afford to retire earlier than planned, Black retirees left work early because of a health problem or disability.

If you find yourself needing or wanting to retire early, you might have to make a decision between a pension or a lump-sum payout.

Common Causes of Early Retirement

In an analysis conducted at the Center for Retirement Research at Boston College (CRR) in 2019, it was concluded that health is likely to be the largest factor in early retirement. Layoffs and job loss were highly influential as well, but much of the forced retirement in this category was mitigated by retirees finding more work.

The same CCR study found that those in the forced retirement category, who did not find new jobs, tended to become discouraged; they stopped looking for work and joined the ranks of the non-working early retired.

If you happen to face forced retirement with severance, you may have to choose either a lump sum payout or a pension plan. This is not an easy choice, but there are steps you can take to feel confident in your decision. The first step is to determine which option will be best for you. There are a few methods of doing this—a popular one is the 6% test.

The 6% Test

Many people who take the lump sum invest at least a portion of it so the money can grow and bolster their retirement savings. The 6% test is a way of gauging whether the lump sum is significant enough to grow at a rate that resembles pension payments.

To determine whether or not your pension passes the 6% test, multiply your monthly pension payment by 12. Divide this number by the lump sum offer, then multiply by 100.


( ( Monthly Pension Payment X 12 ) ÷ Lump Sum Offer ) X 100 = Annual Return Needed on Lump Sum in Percent Form

As an example, consider a scenario in which a retiree is asked to choose between $1,000 a month for life beginning at age 65 and a $160,000 lump sum payment today. A $1,000 monthly pension payment multiplied by 12 equals $12,000. Divide $12,000 by $160,000 and you get 7.5%.

The person in this scenario would have to earn approximately 7.5% per year on the $160,000 to mimic the steady monthly payments of the pension plan. Earning 7.5% a year consistently is a tall task, especially since retiree investments are on a relatively short timeline. That means the monthly amount may be a better deal in the long-term.

As a rule of thumb, it's more realistic to expect your lump sum to earn less than 6% per year in investments. If you can earn less than 6% and still make more than your pension plan payments, the lump sum payout may be your best bet.

Typically, part of the funding a pension plan uses is the money you and your employers have placed in the fund over the years. On your own, you can generally withdraw 5% per year from your total pension funds, making your money last for about 20 years.

Other Financial Factors to Consider

The calculations are an important step, but they're the first step. After you do the math, there are several additional factors to consider before deciding if a lump sum or a pension is right for you:

  • Consider the age when your monthly pension payments begin vs. when the lump sum pays out.
  • How much longer can you realistically expect to live? It may be a bit morbid to consider this one, but it's a crucial piece of retirement planning. The longer you live, the more valuable a lifetime monthly pension plan becomes.
  • Consider the details for your pension plan. Is it based just on your life, stopping after you die, or does it continue to cover your spouse’s lifespan?
  • How stable is the company promising you the pension? If you're worried about the pension company going out of business, look to see whether the plan is backed by the Pension Benefit Guaranty Corporation (PBGC), which helps guarantee your income.
  • Take stock of your entire financial portfolio, including any additional forms of retirement savings. Then, consider whether this amount is sufficient to cover any sudden emergency payments. If not, it could be another benefit to taking the lump sum payment.

Ways to Use Your Retirement Package

After you have a good idea of whether you're going to take the lump sum or pension, consider some common ways people use their retirement funds. These shouldn't be primary factors in your decision, but they can help you clarify your retirement plan.

You should find out if your retirement package includes health care. If you don’t qualify for Medicare yet, you should learn if your health care expenses will be covered under a retirement planand set aside funds for health care if not. If so, this is one expense you won’t have to worry about in your early retirement.

Another option is to use the buyout and leave retirement savings alone. This would mean budgeting your buyout to use it as income until it runs out. This way, your retirement savings remain untouched for when you truly need it.

Consider using the buyout to pay off or pay down any debts. Using the cash windfall from a buyout to pay off your debts can be a good move. You could pay off your mortgage, your car, or get rid of monthly credit card balances so you can reduce your overall expenses.

Another option if you are given an early retirement with a severance, is to save and invest the buyout and find a new job. An unplanned retirement doesn’t mean you have to stop working entirely. If you can find a job in your field or take on a part-time job doing something you love, your retirement package is money that can be put into your savings. You could also use it to pay for your monthly necessities, while your new job helps you accumulate more wealth or pays for retirement activities.

Was this page helpful?
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Employee Benefit Research Institute. "2021 Retirement Confidence Survey Summary Report," Page 2.

  2. Center for Retirement Research at Boston College. "Retiring Earlier Than Planned: What Matters Most?"

Related Articles