Pension: Lump Sum or Income for Life?
The question is not which number is bigger. It is what return the pension implies on the lump sum you would give up. $2,200 a month against $400,000 is 6.6% a year, guaranteed for life. To beat that by investing the lump sum yourself, you need 6.6% every year - and you need to not outlive the money.
Reframing the question
A pension offer arrives as two numbers: a lump sum, or a monthly income. People compare them by trying to imagine which is bigger over a lifetime, which depends entirely on how long they live - a thing nobody knows.
There is a better question.
What return is the pension paying on the money you would be giving up?
$2,200 a month is $26,400 a year. Against a $400,000 lump sum, that is:
| Figure | |
|---|---|
| Yearly pension | $26,400 |
| Lump sum offered instead | $400,000 |
| Implied return | 6.6% a year |
Now it is a comparison you can actually make. To do better with the lump sum you need to beat 6.6% a year - and never run out.
Why that is a high bar
6.6% is not an outrageous return to hope for. It is an outrageous return to guarantee.
The pension pays it whatever happens. No bad decade, no bad decision, no risk of the money finishing before you do.
Investing the lump sum means:
- Earning above 6.6% on average, and
- Surviving the years when you do not, and
- Not outliving the pot
| If you earned | Against the pension |
|---|---|
| 3% | Pension wins comfortably |
| 5% | Pension wins |
| 6.6% | Level |
| 8% | Lump sum wins - if 8% actually arrives |
That last row is the whole risk in one line. The pension needs no luck at all.
The break-even
The pension also matches the lump sum after 15.2 years - that is $400,000 divided by $26,400.
Live longer than that and the pension pulls ahead, for as long as you live. Live less and the lump sum was worth more.
Which is why health and family history matter more here than any rate of return.
The question that changes everything
Does the pension rise with prices?
Most private schemes do not. Over 25 years the difference is enormous:
| Over 25 years | Total paid |
|---|---|
| A pension that never rises | $660,000 |
| One that rises with prices | $962,525 |
Over $300,000 of difference, from a single feature that is rarely mentioned in the offer.
And if yours does not rise, remember what that means in practice: at 3% inflation, $26,400 in 25 years buys what about $12,600 buys today. The cheque never changes; what it buys halves.
Three things to ask before deciding
What happens when I die? Many schemes pay a reduced amount to a spouse - often half. Some pay nothing at all. A single-life pension that pays more now but leaves your spouse with nothing is a decision about their future, and it should be made together.
Does it rise with prices? See above. It is worth more than almost anything else in the offer.
Is the scheme insured, and up to what limit? Most private schemes are covered by a government-backed guarantee, usually up to a cap. If your promised income sits well above that cap, the part above it carries real risk - and that is worth knowing before turning down a lump sum.
None of those three appear on the offer letter. All three change the answer.
When the lump sum is genuinely right
Poor health. An income for life is a bad bet if you have reason to think life will be shorter than average.
You want to leave it to someone. A pension usually dies with you or a spouse. A lump sum can be inherited.
You need flexibility. Some retirements have expensive early years and cheaper later ones. A fixed monthly income does not bend.
Real doubts about the scheme, particularly if your income exceeds the insured cap.
What to do
- Work out the implied return. Yearly pension divided by the lump sum.
- Ask honestly whether you would beat it - every year, without running out.
- Find out whether it rises with prices. Worth more than most of the rest.
- Ask what a spouse would receive.
- Check the insurance cap against your promised income.
Run your own offer through the pension calculator - it works out the implied return and shows what you would need to earn to beat it.
Common questions about pension: lump sum or income?
How do I compare a lump sum against a pension?
Work out what return the pension income represents on the lump sum. $2,200 a month is $26,400 a year; against a $400,000 lump sum that is 6.6%. That is the figure you would have to beat by investing it yourself, with none of the guarantee. If you cannot confidently beat it, the pension is the better deal.
What does the implied return actually mean?
The pension hands you 6.6% of that lump sum every year, for life, whatever markets do. Beating it means earning more than 6.6% every year AND never running out. That is a high bar, and it is the honest way to frame the comparison.
Why would anyone take the lump sum?
Control, inheritance, and doubts about the scheme. A lump sum can be left to your family; a pension usually cannot. You can take more in the years you want it. And if you are in poor health, an income for life is a poor bet.
Does it matter whether the pension rises with prices?
Enormously, and most private schemes do not rise. Over 25 years a rising pension pays $962,525 against $660,000 for a flat one - nearly $300,000 more. Ask your scheme which yours is; many people never do.
What should I ask before deciding?
What happens to the income when you die, whether it rises with prices, and whether the scheme is insured and up to what limit. Those three answers change the decision more than any calculation, and none of them appear on the offer letter.