Pension lump sum vs annuity: the return the checks imply
Many pension plans offer a choice at retirement: a single lump-sum payment, or a monthly annuity for life. The two are hard to compare directly because one is a pile of money today and the other is a stream of checks whose total value depends on how long they last. The Pension Lump-Sum vs Annuity tool converts the election letter into two figures that can be compared: the annual return the annuity effectively pays on the lump sum, and the age at which the checks overtake the lump sum invested at a return you choose.
The decision it answers
The tool answers one framing question: what yearly return would the lump sum have to earn, every year, to reproduce the annuity checks to a given age? A second tab asks the longevity question from the other side: if the lump sum were invested at a chosen rate, at what age would the cumulative annuity checks catch up, if ever? It does not tell anyone which option to elect.
How the tool computes it
Building the check stream
calcA() calls buildPays() to list every monthly payment from your age to the life-expectancy age you enter, stepping up once a year by any cost-of-living adjustment (COLA), and optionally continuing at a reduced survivor percentage to a second age for a joint-and-survivor option.
Solving the implied return
irrFromPays() finds the monthly rate at which the present value of that stream, with payments at the end of each month, equals the lump sum, using bisection. It annualizes the result as (1 + monthly rate) to the 12th power minus 1. If the lump sum is at least the total of every check, it reports less than 0%.
Break-even age
calcB() grows the lump sum at your chosen return, compounded once per whole year of age, and adds up annuity checks without reinvesting them. It finds the age where the running total of checks first passes the grown lump sum, interpolating between whole ages, or reports never if that does not happen by 100.
Worked example
These inputs are hypothetical, not a real person or account. The results were produced by running the tool's own calculation code on them.
- Lump-sum offer: $300,000
- Monthly annuity: $1,700, no COLA, single life
- Age at election: 65
- Life-expectancy age used: 87
- Break-even tab returns tested: 1%, 2%, 3%, 4% and 5%
- From 65 to 87 is 264 monthly checks. Added up with no discounting they total $448,800.
- Solving for the rate at which $300,000 would pay out exactly those 264 checks gives an implied return of 4.01% a year.
- Living past 87 raises the effective return and dying earlier lowers it, which is why the second tab exists.
- At a 1% assumed return on the lump sum, the cumulative checks overtake it at about age 82.5. At 2%, about age 88.4.
- At 3%, 4% or 5%, the tool reports that the checks never catch up by age 100.
- Through age 90 the annuity pays $510,000 in cumulative checks in this example.
In this hypothetical, the annuity implies about 4.01% a year to age 87, and the break-even age appears only at assumed returns of 2% or less.
Assumptions and limits
- There is no mortality table. Longevity is the single age you enter, so the implied return is for that exact lifespan.
- The two tabs measure different things. The implied return discounts every check; the break-even tab adds checks up without reinvesting them while the lump sum compounds. That is why, in the example, the annuity implies 4.01% yet never breaks even against a 3% invested lump sum: reinvested checks are not credited.
- Taxes are ignored on both sides. Lump sums and annuity payments are generally taxable, and a lump sum rolled to an IRA is taxed differently from one taken in cash.
- The break-even tab has no survivor option and compounds the lump sum once per whole year of age.
- The rating bands (6% or more strong, 4.5% or more solid, 3% or more middling, otherwise weak) are the tool's own labels, not a market benchmark.
- Plan funding, insurer guarantees and any PBGC coverage are outside the calculation.
Sources for the rules on this page
Run it with your own numbers
The Pension: Lump-Sum vs Annuity is free, but it needs a free Obsidian Metrics account: signed-out visitors are sent to sign in first.
Frequently asked
What is the implied return of a pension annuity?
It is the annual rate at which the lump sum, invested and drawn down, would produce the same checks to the age you enter and run out exactly at the end. The tool solves for it with bisection on a monthly rate and annualizes the result.
Why does life expectancy matter so much?
Every extra year of checks adds to the annuity's value, so a longer lifespan raises the implied return and a shorter one lowers it. The tool uses a single age you enter rather than a mortality table, so testing several ages shows the range.
Can the tool model a COLA or a survivor benefit?
The implied-return tab can step payments up by a yearly COLA and continue a reduced survivor percentage to a second age. The break-even tab supports a COLA but not a survivor option.
Does it include taxes?
No. Both tabs compare pre-tax amounts. How each option is taxed depends on how it is paid out and on the rest of your income, which is a question for a tax professional.
Does the tool say which option to choose?
No. It reports an implied return, a total of checks and a break-even age for the inputs you give it. You can copy or print a summary to discuss with an advisor or spouse.
More decision tools: Roth Conversion Calculator, Balance-Transfer Calculator, PMI Removal Decoder, 401(k) Rollover Decoder.
Talk it through
The free Obsidian Metrics community on Skool is where members discuss decisions like this one and the frameworks behind them. It is education, not personal advice.