Pension Lump Sum vs. Annuity

A defined benefit plan promises a monthly benefit, usually for life: in effect, an Annuity your employer funds. Some plans also let you take that promise as a single payment, at retirement, when you leave the employer, or in a limited-time buyout offer, sometimes even after monthly payments have begun. Some allow part lump sum and part annuity. Unless the plan later makes a new offer, the choice is generally final once payments start.

Married participants start from a default. In private-sector plans, federal law makes a qualified joint and survivor annuity the standard form of payment, continuing 50% to 100% of the benefit to the spouse for life after the participant dies. To take a lump sum or a single-life annuity instead, the spouse must consent in writing, with the signature witnessed by a notary public or a plan representative. The rule exists because the choice affects two lives: after the first death, a household may be left with one Social Security survivor benefit and whatever pension continues.

A lump sum is the present value of the monthly checks you give up. Each future payment is discounted for interest and for the chance you will not be alive to collect it. Federal law sets a floor on that value: under §417(e) of the tax code, plans must use the IRS applicable mortality table and three corporate-bond segment rates published monthly. The first rate discounts payments due in the next 5 years, the second those due in years 5 to 20, and the third anything later. Plans may pay more than this minimum.

Interest rates and lump sums therefore move in opposite directions: when corporate bond yields rise, the same pension is worth a smaller lump sum. For May 2026, the IRS rates were 4.42%, 5.47% and 6.31%. The plan’s terms fix which recent month’s rates apply, so an offer can change noticeably from one year to the next while your pension stays the same.

Start by turning the offer into one number. Divide the yearly pension by the lump sum to get its implied payout rate, then ask what the same income would cost elsewhere. A quote for a single premium immediate annuity with the same start age and survivor terms shows what an insurer would charge to replace the pension; if the lump sum would not buy that income, the pension is the richer option on paper.

Next, test how long the money lasts. The worked example finds the age at which a lump sum paying the same income runs dry. Compare that age with realistic lifespans for you and your spouse, because longevity risk is exactly what the annuity removes. Then weigh what the arithmetic leaves out.

Monthly pension payments are ordinary income as you receive them, apart from any after-tax contributions you made, which come back tax-free. A lump sum is ordinary income in the year it is paid unless you roll it over.

A direct rollover to an IRA or another employer plan keeps the money tax-deferred, with nothing withheld. If the plan pays you instead, it must withhold 20% for federal tax, and you have 60 days to deposit the full amount, making up the withheld 20% from other money, or the shortfall is taxed. Rolling straight to a Roth IRA is allowed, but the pre-tax amount then becomes taxable, as with a Roth conversion.

Money taken before 59½ can also owe the 10% additional tax. The rule of 55 exempts payments from the plan after you leave the employer in or after the year you turn 55, earlier for qualified public safety employees. The exception does not follow the money into an IRA, so IRA withdrawals before 59½ face the 10% tax again.

Keeping the annuity means relying on the plan, but most private-sector pensions are insured by the Pension Benefit Guaranty Corporation (PBGC). For single-employer plans that end in 2026, it guarantees up to $7,789.77 a month for a straight-life annuity starting at 65, less at younger ages or with survivor options (see how PBGC insures a pension). Once you take a lump sum, the money is yours to invest and that protection no longer applies. If an employer transfers its pensions to an insurance company, state guaranty associations become the backstop instead, up to their limits.