The Pension Series (Part 11) : Pension Lump Sum Case Study

Pension Lump Sum Case Study

Hello! If you are a ChooseFI listener who made their way here to read my response to a ChooseFI listener’s pension question in Episode 58R, you’re in the right place! You can probably skip the Context section and go straight to the case study if you want. Also, if you’re one of the many listeners and readers who reached out to me as a result of my interview in Episode 57, thank you. I’d like to thank Jonathan and Brad as well for providing me the opportunity to spread the Golden Albatross message!

Pension Lump Sum Case Study
ChooseFI … it does what the label says.

On the other hand, if you have no idea what I am talking about, read the context portion. I wrote it just for you…

Context Is Key

Pension Lump Sum Case Study
There’s Jonathan and wife (I assume).

In late 2017, Jonathan Mendonsa and Brad Barrett from the ChooseFI podcast interviewed yours truly. It proved a great experience. When the episode aired on 08 JAN 2018, it generated a lot of traffic to my blog, FaceBook (FB) group, and FB page. It turns out though, that my interaction with Choose FI listeners was destined for more than one interview and intermittent responses in the ChooseFI FB group to pension questions. Jonathan and Brad asked me to joint their team as the resident researcher for pension questions based on my pension “expertise”. I guess pickings were slim when it came to bloggers who write about Financial Independence (FI) and Pensions! I didn’t have enough happening in my life between my family, military career, and blog; so I said “yes”.

There’s Brad and family. I hope he’s feeling better.

They didn’t waste any time either. I caught my first listener question on Christmas weekend 2017 .. with a due date of 12 JAN 18. They asked for an answer before their weekly round up episode, in which they review what they learned from the week’s interview and answer listener’s questions. Of course, that was the intended week of my interview, so it played into the overall theme of pensions for the week. I was happy to provide. Unfortunately, Brad got sick during the week of 12 JAN, so they pushed my listener question and answer to Episode 58R on 19 JAN 18. No big deal, we got there in the end.

Pension Lump Sum Case Study
Grumpus Maximus in the wild.

Thus, this post is the written version (with better grammar) of the same pension lump sum case study I read out loud on ChooseFI Episode 58R. You can find Tess’s (the listener’s) seemingly simple question at 38m53s into the episode, and my long winded response immediately following. You’ll need to at least listen to her question to understand my response.

Right onto my overly complicated answer to Tess’s question.

The Set Up

Whether or not a person should take a pension lump sum is the pension question I see asked most often in the ChooseFI FB group. As a result, I hope this proves an enlightening discussion for a portion of ChooseFI listeners.

Tess asked a seemingly simple question for which no simple or precise answer exists. To paraphrase in terms I use on my blog, Tess wants to calculate the Total Dollar Value (TDV) of her three different pension options in today’s dollars in order to compare them to her company’s lump-sum offer (also in today’s dollars).

One of the reasons there is never a precise answer to the TDV question is due to the vague nature of all retirement planning. Most importantly none of us know how long we will live! Nor do we know exactly what our rate of return or inflation rates will be. Thus, the clear mathematical answer Tess desires is an estimation at best, and a guess at worst.

Dude .. I just showed you my picture. There’s no way this Gorilla will fit in there.

Pension Lump Sum Framework

Since some estimations are better than others, it’s best to understand what we are dealing with, so let’s discuss some general facts about pension lump sums in order to frame our discussion.

Why do private pension funds, or any pension fund for that matter, offer lump sums? I will tell you it’s not out of the goodness of their hearts. No, pension funds offer lump sums primarily because it allows them to transfer risk at a discounted rate to the pensioner.

In other words, the company transfers the future risk of running out of money with which to pay the pensioner over to the pensioner in the present day. By taking a lump sum the pensioner incurs the risk of running out of money in the future, not the pension fund. Assuming the pensioner actually invests the money (a big assumption in my opinion), the pensioner runs the risk by not employing an appropriate Safe Withdrawal Rate (SWR) and therefore withdrawing all their money prior to death. As ERN McCracken has written about prolifically; employment of a SWR can be a tricky thing if an investor does not understand the facts and math.

The U.S. government further incentivizes the risk transfer from company to the pensioner with its rules that govern pension lump sum calculations. Most importantly, the rules allow companies to use what an article at calls “unrealistically high rates of return” for a lump sum invested by the pensioner. Higher than normal rates of return from an invested lump sum (again assuming the lump sum gets invested at all) forces the pensioner to reach for returns to achieve the same value that an annuitized payout would offer.

No surprise there …

The U.S. government also forces companies to use the government’s longevity estimates which inexplicably combines male and female longevity into one table. This is unfair to women offered lump sums since U.S. women statistically live longer than men. Conversely, for U.S. males, this unfairly bumps up their lump sum offer.

Since companies are legally allowed to “low-ball” their pensioners, TDV calculations almost always end up greater than the pension lump sum offered. Thus, anyone looking to compare a lump sum payout to the future value of their annuitized pension using today’s dollars should brace themselves. In rare cases, inflation mitigates this effect, but that isn’t the norm in my experience. If Tess wants a good article explaining these issues further, she can go to the article by William Baldwin (not the actor) I reference above. The article also provides a calculator which (supposedly) mitigates the flaws in U.S. based lump sum calculations and offers a true lump sum calculation.

Pension Safety

The final factor to understand up front in any lump sum discussion is pension safety. Pension safety is something of a trump card (no pun intended) when it comes to lump sums. If a high likelihood of pension fund failure exists, then no matter how “low-ball” the lump sum offer, a pensioner will probably take it.

“Danger Will Robinson, Danger!”

That said, pension safety is an area many people, including many of the ChooseFI Facebook followers, tend to misunderstand. Much of the advice I see in the ChooseFI FB Group generally equates to “assume your pension won’t be there for you, and if it is, it’s just icing on top of the cake”. If that were true, then logic should dictate that everyone take the lump sum offer.

But it’s not true. Each pension fund is run and managed separately from one another. To say that all pensions are doomed is not only inaccurate, but unhelpful to those trying to use a pension to help them achieve FI.

Thus, I would advise anyone in Tess’s situation to dig into the financial details of their pension fund. Pension funds and the companies that own them are required to produce annual statements and reports which disclose how well funded the pension fund is. If for some reason Tess cannot find those reports for her particular company, then I would recommend she go to Boston College’s Center for Retirement Research and see what information they have among their reams of reports on pensions. By doing this, someone should be able to build a much better estimate of the likelihood that their pension fund might fail in the future.

For a private pension, let me further point out that all may not be lost even if the pension fund fails. Many private and union pension funds in the U.S. belong to the Pension Benefit Guarantee Corporation (PBGC). The PBGC is a U.S. Government-backed insurance scheme meant to act as the final backstop for all pension funds who are paying members. However, the PBGC itself is massively underfunded and in need of much reform, which limits its usefulness. Currently, if the PBGC assumes the financial liabilities of a failed pension fund it only pays out about 60% of what is owed to a pensioner.

Don’t worry, they got about 60% of your back.

Facts and Assumptions

So with that long-winded framing of Tess’ question out of the way, let’s discuss the important facts and assumptions about Tess’ pension and lump sum offer:

  • We’ll assume Tess is asking about herself, not a spouse, and use female life expectancy rates
  • We know Tess’s pension is a private pension since she mentioned a company
    • No details on which company, so no ability to judge pension safety or if it’s a U.S. company
      • We’ll assume the pension is safe, and the company is U.S. based

      No ability to judge if the company’s a member of the PBGC

      • We’ll assume it is a member; although it doesn’t matter for this scenario
    • No ability to judge if the company’s a member of the PBGC
      • We’ll assume it is a member; although it doesn’t matter for this scenario
  • No survivorship consideration (as relayed via email)
  • No mention of a cost of living adjustment (COLA)
    • We’ll assume there is no COLA, which means inflation is at play
    • We’ll assume a 2% annual rate of inflation for all calculations
  • I didn’t see in the email or hear in the voice mail (VM) about any other pension benefits like healthcare
    • We’ll assume there are none
  • Tess is 48 (according to follow-up email) so has 7, 12, or 17 years to wait until pension payouts start; depending on which choice she makes
    • Assuming no COLA, that’s 7, 12, or 17 years of inflation eating away at the value of her payouts before they start
    • This means the value of the different monthly payouts offered ($690, $1066, and $1254) would respectively be worth $601, $841, $896 in today’s dollars when those payouts start. I made those calculations with this inflation calculator at
    • Finally, since Tess’s pension doesn’t start immediately, she needs to understand the Immediacy Effect as discovered and described by Big ERN McCracken in his 17th article of the Safe Withdrawal Rate Series
      • It’s worth a read, but I’ve yet to figure out how to value the immediacy effect mathematically for TDV calculations


Oh yeah, it’s just like that.

Right, I’m ready to make the TDV calculations now. Here’s how I do it for a situation like Tess’s. Take the inflation-adjusted monthly payouts I noted above, and turn them into annual amounts. Then multiply the various totals by the number of years left from the start point of each pension payout to the end of Tess’s assumed life. Finally, adjust that total again for inflation using the calculator. That should provide three different TDV’s in today’s dollars to compare the $75.5K lump sum.

Scenario #1 Age 55 Pension Pay Out

  • $601 x 12 months = $7212 per year
  • $7212 x (83 – 55 years) = $201,936 non-inflation adjusted cash value
  • $201,936 adjusted for 2% inflation over 28 years (83 – 55 years) =
    • $115,987 TDV in 2017 dollars

Scenario #2 Age 60 Pension Pay Out

  • $841 x 12 months = $10,092 per year
  • $10,092 x (83 – 60 years) = $232,116 non-inflation adjusted cash value
  • $232,116 adjusted for 2% inflation over 23 years (83 – 60 years) =
    • $147,198 TDV in 2017 dollars

Scenario #3 Age 65 Pension Pay Out

  • $896 x 12 months = $10,752 per year
  • $10,752 x (83 – 65 years) = $193,536 non-inflation adjusted cash value
  • $193,536 adjusted for 2% inflation over 18 years (83 – 65 years) =
    • $135,506 TDV in 2017 dollars

Comparison of TDVs to Lump Sum Offers

Wahay, we did it! Not only did we determine today’s TDV for Tess’s future pension payouts, but we also discovered that Scenario 2 provides the most money over her life expectancy (if our assumptions hold true). About this point is where I typically caution readers to remember the TDVs are at best estimations! Tess actually has to make it to 83 years of age to realize this scenario. Not only that, but she has to die (sorry Tess) at 83 for this to hold true too. Finally, our 2% inflation rate has to hold true over the lifetime of our scenario as well.

Those are a lot of assumptions, and they don’t include any of the other assumptions I made about Tess’s pension due to a lack of information. For instance, the addition of other pension benefits like healthcare, or a major pension safety concern, seriously complicates comparing a TDV to a pension lump sum. If that happens to be anyone else in the audience, then refer to Part 8 of my Pension Series for more detailed comparison methods.

However, in Tess’s case let’s assume everything is true up to this point and holds true throughout the lifetime of our TDV scenarios. As a result, I would recommend she concentrate on the difference between Scenario 2 and the lump sum offer. That comparison truly highlights the “low-ball” effect I described towards the beginning of this response. Tess’s lump sum offer is worth approximately half of what she’s owed in Scenario 2. Not good, but that’s what the U.S. law allows.

“Yoooou are an 18 year old girl who lives in a small city in Japan”. OK, that’s a Weezer song. I’ve no proof that Financial Samurai actually lives in Japan.

One last point worth noting, my method isn’t the only one out there for calculating pension lump sums. Both Financial Samurai and Actuary on Fire also wrote fairly extensive posts on how to value a pension. Actuary’s is probably the easiest, as it makes a lot of assumptions, and uses the XNPV function on MS Excel. Actuary’s method and mine are conceptually similar since we both base our calculations on the potential amount earned, discounted for inflation. Financial Samurai uses a Rate of Return method for comparing the value of a pension, which is something I don’t do. This illustrates the point I was trying to make at the beginning of this post though. Since there is no precise method for calculating TDV for a pension, there is no one correct method.


At this point, it’s over to Tess for her determination as to what to do. The TDV estimates argue for Scenario #2, but then again that doesn’t take into account what’s going on her personal life. As Airmen Mildollar likes to say, personal finance is personal; which means no two pension lump sums comparison scenarios will be the same. And as Brad Barret likes to point out on the ChooseFI podcast all the time, people value different things as well. All I’ve done is arm Tess with knowledge by showing her a way (not the way) to estimate her pension’s Total Dollar Value (TDV). She can use that knowledge to compare it to her lump-sum offer, but what she chooses to do with that knowledge is up to her. Best of luck Tess!

Post Script

I like doing these. If you’re interested I can run a TDV, pension lump sum, or FI pension scenario for you. I will emphasize I am neither a math genius, nor a trained professional though. However, anyone can learn to make these calculations; they just don’t necessarily have the time. The only “payment” I ask for in return is the permission to anonymize the data, and publish it as a case study article! Your call.

The Pension Series (Part 5): Survivorship (Updated)

Substantive Correction

This is an updated version to my article originally posted 04 October 2017. This version includes a substantive correction. The previous version of the article failed to accurately describe all the calculations required when comparing a pension with an inflation-linked Cost of Living Adjustment (COLA) to life insurance. I noticed my omission today and reworked the affected paragraphs. I also took the opportunity to clean up some grammar. You will see substantive changes noted in red text. I believe the changes make the comparisons between life insurance and survivorship more competitive.

The incomplete calculations I described in the previous version of my article appeared weighted towards survivorship. That was not my intent. Since the intent of the article changed, and I believe in full disclosure with my readers; I felt this mistake warranted a revision with new publish date.

This is a first for me in the blogging sphere, although in the military we routinely  strive for this level of transparency when an official report, memorandum, or instruction contains a major mistake. The primary purpose for issuing a correction is to prevent anyone from acting on erroneous information. It’s also important that the historical record reflect accurate information. I’ve decided to hold myself to the same standard on this blog.

As a result, I advise anyone who read and used the methods described in the previous version of this article to read this update and adjust your calculations accordingly. While I apologize for the inconvenience, and always strive for 100% accuracy in my articles; I would remind everyone I’m not a professional. Nor am I considering your case specifically. No matter how comfortable you are with your retirement numbers and plan; it’s always best to run your plan by a professional like a fee-only Certified Financial Planner who adheres to the fiduciary standard.  Again my apologies.

KJH, we honor the fallen in the Grumpus Maximus family.

Death Sucks

In late Summer 2003, a member of my unit and one of its seasoned mentors was killed in the early days of the Insurgency in Iraq. We were both part of a tight-knit group of young officers that worked and played hard. While I would not have called him a close friend, many in our group did, and I often sought advice and guidance from him. His death was a blow to everyone in our group and the unit as a whole. Nothing was the same after it. Most of us were not prepared mentally and we all took it personally. Each of us dealt with his death in our own way, and I am sad to say it splintered the group in ways I never could’ve foreseen. Continue reading The Pension Series (Part 5): Survivorship (Updated)

The Pension Series (Part 10): Geoarbitrage and Pensions

Where in the World …

… is Grumpus Maximus?

In Part 9 of the Pension Series a reader’s question prompted me to research the interplay between the U.S. Federal tax code and pensions. My reader, Mr. Yankee, wanted to know what options existed to minimize Federal taxes when pension payments started for him and his wife, Mrs. Doodle. I found a few specific instances to defray some Federal tax, but nothing major. Turns out Mr. Yankee already knew the most powerful tax options available to him. What did Mr. Yankee know? He knew that in the U.S., geography mattered when it came to taxes — specifically at the State level.

For my one non-related international reader, it may seem strange, but in the U.S. we tax income more than once. We typically tax it at the Federal and the State level, and sometimes even at the local level. Furthermore, pension payments typically count as income no matter the source. As I chronicled in Part 9 of the Pension Series, everyone who receives a pension is (typically) subjected to Federal tax. However, not every State in the Union taxes income. Nor does every State tax pension payments as income. Continue reading The Pension Series (Part 10): Geoarbitrage and Pensions

The Pension Series (Part 9): Pensions and U.S. Federal Taxes

***This is an updated article. See Post Script at the bottom***

Today’s topic comes from one of my Facebook group followers.  I recently solicited my Golden Albatross group on subjects to research and write about, and Mr. Yankee responded with the following question:

Has there been discussion of how to shelter your pension benefits from federal tax? When I retire I expect to receive about $60,000 a year from my pension I’d hate to give a large portion of it back to the government.

I told Mr. Yankee I would look into it since I’d yet to conduct an in-depth analysis of pensions and taxes. It’s a bit premature considering the fact that U.S. tax law is undergoing its first major overhaul since the 1980s. Currently, the House and the Senate are working on reconciling their two different bills into one in order to approve and send to the President for signature. However, my research only shows one proposal in the House bill with the potential to impact this conversation in any meaningful way, and I believe I can address it appropriately. If something radical happens in the reconciliation process, I will simply update this article when the dust settles. Continue reading The Pension Series (Part 9): Pensions and U.S. Federal Taxes

The Pension Series (Part 8): Deciding to Take a Pension Lump Sum

We Interrupt Your Previously Scheduled Program …

Great news! You don’t have to read me waffling on about analyzing your pension lump sum offer this week at I published Part 8 of the Pension Series as a guest post for Darrow Kirkpatrick’s blog,, so you can read my waffling there instead.  Check it out at the following link.

Darrow’s site is a long time favorite of mine.  It is the one sight, more than any other, that inspired me to make the calculations and determine if early retirement was possible for myself and my family. Avid readers of my blog may already be familiar with his work as I reference it quit a bit. Luckily a mutual friend put Darrow and I in touch, and I now get to consider him a mentor and a friend.  Many thanks to Darrow for providing me the opportunity to write for his site, and gain exposure for the Golden Albatross message and  Darrow does not allow comments on his website, but feel free to post them to this article and let me know what you think.


— GM


The Pension Series (Part 7): How to Create Your Own COLA

St. George’s Thesis

Build Your Own Cola
“Cry — God for Harry! England and Saint George!”

How was your week? Productive I hope.  I spent most of my spare time drafting my pièce de résistance for the Pension Series as a guest post for one of my favorite blogs and bloggers. I’m excited, so stay tuned for the announcement as to when and where you can find it. Unfortunately, it means I’m short an article because I (stupidly) don’t keep any posts in the bank.

However, I am about to let you in on a little blogging secret.  Facebook provides an endless amount of material to write about. As proof of this point, about 10 days ago George, one of my awesome Golden Albatross Facebook Group members, asked the following sizzler of a question related to pensions and inflation-adjusted Cost of Living Allowance (COLA):

Basically, if my pension is say $50k [a year] with no COLA provided by my employer, what do I have to have saved in an IRA to be able to grow my pension with cost of living for the next 30 years? (50k+4%)+4%)+4%)etc. For 30 years…)
Continue reading The Pension Series (Part 7): How to Create Your Own COLA

The Pension Series (Part 6): Valuing Pension Subsidized Healthcare

Grumpus the Second Confessor

Pension Subsidized Healthcare
A sin of omission

I have another confession to make to my dear readers (that makes two for those keeping track). When I covered how to calculate the Total Dollar Value (TDV) of your pension in Part Four of this series, I purposely restricted the calculations to retirement income owed to a retiree through a pension fund. I didn’t include Other Post-Retirement Benefits (OPRBs), alternately known as Other Earned Benefits (OEBs). For those of you unfamiliar with OPRBs, Investopedia defines them as:

Benefits, other than pension distributions, paid to employees during their retirement years. Most post-retirement benefits include life insurance and medical plans.

Some other examples of OPRBs include tuition assistance, legal advice, and support for funeral arrangements. I excluded OPRBs from my TDV calculations primarily because they are hard to value, and do not necessarily come with price tags attached. In the U.S. at least, no better example of this exists than pension-linked or subsidized healthcare. Continue reading The Pension Series (Part 6): Valuing Pension Subsidized Healthcare

The Pension Series (Part 4): Total Dollar Value (TDV) of Your Pension

Determining Total Dollar Value (TDV)

My original intent for Part Four of this series was to write about good pension calculators found on the web that could help you place a Total Dollar Value (TDV) on your pension.  In fact, I was building up to it from Part One onward.  I felt my topics had a nice and natural progression beginning with pension safety, moving on to whether or not your pension is worth it, and then analyzing the three most important factors in determining the your pension’s worth: the Initial Dollar Value (IDV) formula, inflation’s effect, and the Immediacy Effect.

However, it turns out that most generic pension calculators on the web stink, if you can find one at all.  It also turns out, that most pension plans have their own calculators.  In hindsight, that makes sense because as we discussed in Part Three, each pension plan has its own formula to calculate IDV.  My oversight aside, it doesn’t decrease the importance of determining the TDV of your pension.  In fact, there are several good reasons for doing so, even if the process might prove different than I first imagined. Continue reading The Pension Series (Part 4): Total Dollar Value (TDV) of Your Pension

The Pension Series (Part 3): What is Your Pension Worth?

Calculating Your Pension’s Worth … Ain’t Like Dusting Crops

Anybody else exhausted from Part 2 of the Pension Series?  I know I am.  At 3200+ words it wasn’t concise.  Amongst all those words, you may remember my promise to help you determine your pension’s worth in future posts.  Well, the future is now, or at least partially.  Unlike Part 2 though, I intend to break up the discussion over the next several posts.  How many?  I don’t know yet; at least two, maybe more.  Since calculating your pension’s worth is more of a “how to process”, I hope the articles don’t need to be overly verbose.  I understand people don’t have time to read 3200+ word posts every week, and frankly, I don’t have the time to write them.

For this post, I will examine the three key inputs in determining your pension’s worth.  I will also examine some of the basic mathematical formulas used to calculate your pension’s worth.  I will keep it simple because I am not a math genius by any means (liberal arts major here!), and more than likely you are going to use a pension calculator to make the calculations anyway.  However, you should understand the inputs and formulas because like Han Solo said in “Star Wars A New Hope”: Continue reading The Pension Series (Part 3): What is Your Pension Worth?

The Pension Series (Part 2): Worth vs. Worth It


I’ll admit up front this article won’t be to everyone’s liking which probably isn’t a good way to start out a blog post if you want people to read it.  However, there’s a likelihood that some readers will get no more than a few paragraphs in, and question what the hell any of this has to do with Financial Independence (FI) or pensions.  They may even think all I’m trying to do is blow my own horn.  I’m not, but I could see how it might appear that way if you don’t stick around to the end.  Admittedly, I used this post as an opportunity to engage in some much-needed writing therapy.  One of my Docs told me it would help to write about events from my career which contributed to my PTS.  Thus, dealing with the topic of  “worth vs. worth it” gave me the opportunity to kill two birds with one stone.  I’ll leave the determination of whether I successfully pulled it off up to you. Continue reading The Pension Series (Part 2): Worth vs. Worth It