Pension Lump Sum vs. Annuity: How to Evaluate a Buyout Offer

The lump sum is the present value of your monthly pension, discounted with interest rates and a mortality table the IRS prescribes. Under Internal Revenue Code section 417(e), a private-sector plan's lump sum cannot be less than the value produced by three monthly "segment rates" drawn from corporate bond yields. The first applies to payments in the next five years, the second to years five through twenty, and the third to later years. The mortality table is a single unisex table the IRS updates each year (IRS).

In the spring of 2026, those segment rates ran from about 4.2% to 4.4% for the first segment, 5.3% to 5.5% for the second, and 6.2% to 6.3% for the third (IRS). Two consequences follow. First, when rates rise, lump sums fall. For a pension like the one in our example below, paid for about 22 years, moving the discount rate from 5% to 6% cuts the present value by about 8%. Your plan document names the month whose rates it uses, which is often several months before the payment date, so you can often see next year's change coming. Second, because the IRS table is unisex and population-wide, it overstates life expectancy for some people and understates it for others. A woman in excellent health gets a lump sum priced for an average person, which tends to favor keeping the annuity. A man with a serious illness gets the same average pricing, which tends to favor the lump sum.

Employers offer buyouts because they shrink the plan's obligations, its exposure to longevity and interest rates, and the per-participant premiums it pays to the Pension Benefit Guaranty Corporation. None of that makes an offer bad. It does mean the offer is not a favor, and the timing suits the plan rather than you.

It is the interest rate at which the pension payments, over your expected lifetime, are worth exactly the lump sum. Think of the lump sum as the price of the annuity. If you would need to earn 6% a year on the lump sum to pay yourself the same check until 90, and safe bonds pay 4% to 5%, the plan is selling you income more cheaply than you could make it yourself. If you would need only 2%, the lump sum is the better deal.

The implied return depends heavily on how long you live, which is the whole point. Die early and the annuity returned less than you paid; live long and it returned more than almost any safe investment. So the calculation is not one number but a row of them, one for each plausible age at death. Compare that row with two benchmarks: the yield on high-quality bonds of similar length, and the return you would need from a balanced portfolio to produce the same income at an acceptable risk of running out.

The Annuity Payout Calculator does this in reverse: enter the lump sum, a return and a number of years, and it shows the monthly payment the money could support. Try a few returns. The one that reproduces your pension check is the implied rate for that lifespan.

Richard is 65 and retiring after 31 years with a manufacturer. Carol is 62. They have $1.4 million in 401(k)s and IRAs, $300,000 in a taxable account, a paid-off house, and two adult children. Richard plans to claim Social Security at 70. His plan offers three choices, and the lump sum window closes in 90 days.

We solved for the return that makes each annuity worth $400,000, paid monthly, for different lifespans. For the joint option the lifespan is the second death, shown by Richard's age at that date.

Read the joint column, since Carol would need the income. If one of them reaches 90, the pension has earned 4.4% a year; at 95, 5.3%. That is in the same range as the 4% to 6% corporate bond rates the IRS uses to price lump sums. The offer is roughly fair: neither a bargain nor a poor deal. So the decision turns on what the guarantee is worth to them, not on the arithmetic alone. Another way to see it: $400,000 invested at 4.5% and paying $2,450 a month runs out in about 21 years, when Richard would be 86. At 6% it lasts about 27 years. To beat the joint annuity with the lump sum, they need to take equity risk with it, and to be disciplined enough not to spend it faster.

Our read: take the joint-and-survivor annuity. Both are in good health, Carol is three years younger, and the $2,180 check, added to Social Security, gives them a floor of guaranteed income that covers most of their essential spending. That floor frees the $1.7 million portfolio to stay invested for growth. The lump sum would have made more sense if either of them had a serious diagnosis, if their other guaranteed income already covered their needs, or if they intended to leave most of it to their children.

The case against the annuity is inflation. At 3% inflation, $2,180 buys about $1,200 of today's goods in 20 years. It is a declining real income, and it pays best in the early years. The couple should treat it as the first layer of their plan, not all of it, and let the portfolio and Social Security, which is inflation-adjusted, carry the rising costs later on.

For most private-sector pensions, very safe up to a limit. The Pension Benefit Guaranty Corporation insures most private-sector defined benefit plans. If a plan fails, the PBGC pays benefits up to a legal maximum that depends on your age when payments begin and the year the plan terminates. For single-employer plans ending in 2026, the maximum at 65 is $7,789.77 a month as a straight-life annuity and $7,010.79 as a joint-and-50%-survivor annuity. At 62 the figures are $6,153.92 and $5,538.53; at 70 they are $12,931.02 and $11,637.92 (PBGC, 2026). The PBGC notes that most benefits in the plans it takes over are below the maximum.

The protection has gaps. The PBGC generally does not insure plans of government employers, church groups, or professional service firms with fewer than 26 active employees (PBGC). Multiemployer (union) plans have a separate guarantee with different limits. If your pension is well above the limit, or your plan is not covered, the sponsor's financial health matters more, and the case for the lump sum gets stronger.

The guarantee ends when you take a lump sum, or when the employer ends the plan by buying you an annuity from an insurance company. After that, your protection is the insurer's strength and your state's insurance guaranty association, whose limits vary by state. If your plan announces an annuity purchase, look up the insurer's ratings and your state association's coverage.

If your spouse would depend on the income, choose a survivor option, and choose the level by what your spouse would need. Federal law makes the qualified joint and survivor annuity the default for married participants in private-sector plans. You can choose a single-life annuity or a lump sum only if both of you waive the joint annuity in writing, with your spouse's consent witnessed by a notary or a plan representative (IRS).

Plans usually offer 50%, 75% and 100% survivor options. The higher the survivor share, the smaller the check while both are alive. In Richard's plan, the 100% option costs $270 a month, 11% of the single-life amount. A younger spouse makes the survivor option cost more, because the plan expects to pay longer.

The common alternative, called pension maximization, is to take the larger single-life payment and buy life insurance to replace it for the survivor. It works only if the policy costs less than the difference in payments, stays in force for life, and pays enough to replace the lost income after tax. At 65, a permanent policy large enough to replace a pension for life can be expensive, and it must be kept in force. Get quotes before you waive. Our life insurance guide explains the policy types.

Remember Social Security too. When one spouse dies, the household loses the smaller of the two Social Security checks. A survivor pension often fills exactly that gap. See when to claim Social Security for how survivor benefits work.

A great deal, unless your pension has a cost-of-living adjustment. Many private-sector pensions pay a fixed dollar amount for life; some plans, more often in the public sector, include an adjustment. Your summary plan description says which you have. At 3% inflation, a fixed payment loses about a quarter of its purchasing power in 10 years and nearly half in 20. The Inflation Calculator shows the erosion for any rate.

That does not make a fixed pension a bad deal, because the lump sum is priced on fixed payments too. It changes how you use it. A fixed pension is worth the most in the first decade of retirement, which is also when travel and other discretionary spending tend to be highest. Pair it with Social Security, which is adjusted each year, and a portfolio with enough stocks to grow. In a high-inflation period, holding the lump sum gives you more room to respond, which is a real if unmeasurable advantage.

The annuity is taxed as ordinary income as you receive it, and you can have federal tax withheld from each payment (IRS Topic 410). The lump sum can be deferred entirely with a direct rollover to an IRA or another employer plan. If the plan pays it to you instead, it must withhold 20% for federal tax, even if you intend to roll it over. To avoid tax on the whole amount you would have to deposit the full $400,000 within 60 days, finding the withheld $80,000 from other savings (IRS Topic 413). Fail, and $400,000 of ordinary income lands in one year, much of it in the 35% and 37% brackets.

After a rollover, the money follows IRA rules. Withdrawals are ordinary income, and required minimum distributions start at 73, or 75 if you were born in 1960 or later. That flexibility is useful. You can draw more in low-income years, convert some to a Roth, or give from it directly to charity once you are 70½ through qualified charitable distributions. A pension offers none of those options.

For heirs, the difference is stark. An annuity ends with you and your spouse. A rolled-over IRA passes to your beneficiaries, though most non-spouse heirs must empty it within ten years; our guide to the inherited IRA 10-year rule covers the details. State taxes on pensions vary widely, and some states exempt part or all of pension income, so check your state before assuming the two choices are taxed the same.

Seven, answered honestly, settle nearly every buyout.

A partial answer is sometimes available. Some plans allow part of the benefit as a lump sum and the rest as an annuity. If yours does not, you can build the same result yourself by taking the annuity and holding more of the portfolio in growth assets, or by taking the lump sum and using part of it to buy an income annuity. Either way, decide by the size of the guaranteed floor you want, not by the size of the check on the offer letter.

Finally, get the figures in writing: the lump sum, each annuity option, the interest rates and mortality table used, and the deadline. If the offer is large relative to your savings, an hour with a fee-only planner who does not sell annuities or manage money for a percentage is money well spent; our guide to choosing an adviser explains what to ask.