Question 1

Should I take a pension or lump sum payout?

Accepted Answer

The choice between a pension and lump sum depends on your health, investment discipline, other income sources, and the implied interest rate baked into the lump sum offer. The pension wins if you live a long time, have no other guaranteed income, or would likely spend or mis-invest the lump sum. The lump sum wins if you have above-average investment returns, die earlier than average, want to leave money to heirs, or need flexibility. A key calculation is the internal rate of return implied by the pension — if the pension requires an effective 4–5% annual return to match the lump sum, that is a relatively low hurdle for a disciplined investor.

Question 2

How do you calculate the break-even age for a pension vs. lump sum?

Accepted Answer

The pension break-even age is the age at which cumulative pension payments equal the lump sum amount plus what it would have earned if invested. To calculate: determine the annual pension payment, divide the lump sum by the annual pension to get the number of years to break even on the principal alone, then add the investment returns you could have earned on the lump sum. Most pension break-even calculations fall between ages 78–85. If you have a family history of longevity, the pension increasingly makes sense; if your health is poor, the lump sum may be better.

Question 3

What happens to a pension when you die?

Accepted Answer

What happens to your pension at death depends on the payout option chosen. A single-life annuity pays the highest monthly amount but stops at death, with nothing passing to heirs. A joint and survivor annuity pays a reduced monthly amount but continues paying a percentage (typically 50–100%) to your surviving spouse after your death. A period-certain option guarantees payments for a set number of years (10 or 20 is common) to heirs if you die early. Choosing a single-life annuity and purchasing a term life insurance policy is sometimes more cost-effective than a joint and survivor option.

Question 4

Are pension payments taxable?

Accepted Answer

Yes, most pension payments are taxable as ordinary income in the year received, since they were funded with pre-tax contributions. Federal income taxes apply, and most states tax pension income, though some states exempt certain pension types (government pensions, military pensions) partially or fully. If you take a lump sum, it is also taxable as ordinary income in the year of receipt unless you roll it over into an IRA or qualified retirement plan within 60 days. Rolling over to a traditional IRA defers the tax; rolling to a Roth IRA triggers a taxable conversion.

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